Paper Title: Towards integrated governance: Value based management approach

Transcription

1 Brunel Business School PhD Symposium 2009 Paper Title: Towards integrated governance: Value based management approach First Supervisor: Dr. Magdy Abdel-Kader Second Supervisor: Dr Dimitrios Koufopoulos Student Name: Adel Hassan Elgharbawy Student number:

2 Towards integrated governance Value based management approach Abstract Corporate governance has recently received much attention due to the recent failure of large corporations such as: Enron in the U.S.A. several codes and laws have been introduced to protect the shareholders rights. However, it has been argued that overemphasis on accountability can

3 not guarantee the corporate success and may obscure business prosperity. Consequently, it has been suggested to consider performance as well through focusing on strategy and value creation in order to get the right balance between conformance and performance (integrated governance). On this research, it is argued that using value based management (VBM) approach can achieve this objective. 1-Introduction Corporate governance is considered one of the most controversial issues in recent literature and in practice. Several reports, codes and laws have been introduced worldwide to protect the shareholders rights and to ensure accountability. Nonetheless, recent company failures have revealed that compliance with such codes and laws (conformance) is not enough to ensure effective governance. Poor strategies and ineffective risk management are of equal, if not greater importance of poor corporate governance in explaining these failures. In addition, the overemphasis on accountability can obscure business prosperity. As a result, it has been argued that there is a need to broaden the concept of governance beyond the conformance to a set of rules and laws to include the performance aspects of governance that focus on strategy and value creation (performance). The framework that encompasses and keeps a balance between conformance and performance dimensions of governance is best described as integrated governance. In theory, VBM can be considered as one of the appropriate techniques that address this issue. VBM adopts the value creation as an overall objective, develops a strategy that contributes to the value creation and places the interests of owners of companies at the centre of the decision-making, thus protecting them from possible conflicts of interest arising from the separation between ownership and control. Nonetheless, this potential role of VBM has not been investigated in the literature.

4 This research contributes to the literature by developing a pragmatic approach to translate the construct of integrated governance into practice using VBM as a performance management system. In particular, this research addresses the question of to what extent VBM can improve performance, contribute to a better value for shareholders and protect their rights at the same time?. This research also aims to develop a contingent framework for the implementation of VBM within the framework of integrated governance in order to understand the factors influencing VBM usage and to investigate whether the proper fit between VBM usage and the contextual factors can improve both conformance and performance or not. 3-Literature Review 3-1 integrated governance Reviewing studies that have addressed the issue of the trade-off between conformance and performance (e.g CIMA and IFAC, 2004; Busco et al., 2005) revealed the following limitations in the literature. First, there is agreement between scholars on the importance of the integration of both conformance and performance in one framework. However, there is no complete agreement about the dimensions which can shape this integration. For instance,( CIMA/ IFAC, 2004) argue that the enterprise governance framework should includes the two main dimensions: conformance and performance, while (Busco et al., 2005) have gone a step further and argued that in order to survive, the company can not think only in compliance with a set of rules and principles to meet stakeholder expectations. Instead, it should view accountability toward stakeholders in three perspectives: conformance, performance and knowledge management. Furthermore, Fahi et al., (2005) have claimed that we have to go beyond the governance suggesting a new framework to the enterprise governance including three main dimensions: conformance, performance and corporate responsibility.

5 Second, there are very few studies (e.g CIMA/ IFAC, 2004; Busco et al., 2005) have tried to operationalize the construct of integrated governance and to introduce a practical solution to the trade-off between conformance and performance but unfortunately,they come on a piecemeal fashion they lack the empirical evidence. For instance, (CIMA/ IFAC, 2004) have proposed a new technique CIMA strategic scorecard to be used to assist the board of directors in the oversight of a company s strategic process. However, there is no empirical evidence to support the effectiveness of strategic scorecard in achieving the goal of integrated governance. In theory, VBM approach can be considered as one of the appropriate techniques that address this issue as it adopts the value creation as an overall objective, develops a strategy that contributes to the value creation and places the interests of owners of companies at the centre of the decision-making, thus protecting them from possible conflicts of interest arising from the separation between ownership and control (CIMA, 2004). Nonetheless, this potential role of VBM has not been investigated or empirically tested in the literature. 1-2 value based management The literature suggests that value-based measures (especially EVA) are more correlated to share price than traditional accounting measures (e.g EPS, ROI) and so they are better used as predictors of stock return (Ittner & Larcker, 2001). However, the results of these studies are mixed for instance, Stewart (1991), Lehn and Makhija (1997) have supported the claims of superiority of economic value measures over traditional accounting measures in explaining stock returns. On the other hand, some other studies didn t give any support for these claims for instance; Dodd and Chen (1996) concluded that EVA can explain only a limited percentage of

6 the variability of stock returns in contrast with ROI. Moreover, Biddle et al., (1997) also proposed empirical evidence against EVA concluding that traditional accounting measures give a greater explanatory power of stock returns than economic measures. The mixed results of theses studies raise a number of important questions: First, if the economic value measures as claimed have a significant relation with stock returns, are these measures are preferred for management planning and control purpose ( Ittner&Larcker, 2001)?. Second, do using economic value measures for internal performance measurement and compensation purposes improve the organizational performance for companies that adopt these measures compared to companies that use any other measures? Again the results of studies that have addressed this issue are mixed, for instance, Wallace's (1997) examined the relative performance changes in 40 adopters of residual income-based measures such as EVA and a matched sample of non-users support claims that using these measures lead to a greater positive change in residual income. On the other hand, Hogan and Lewis (2001) concluded that the economic profit plans are not better than traditional plans in terms of their ability to create shareholder wealth. However, the mixed results of these studies have been partially explained by the deficiency in the implementation VBM (e.g. Haspeslagh et al., 2001). Others claimed for deficiencies in VBM itself because its philosophy is based on maximizing the shareholders value on the expense of other stakeholders. This research argues that contingent factors can play an important role in explaining such mixed results. This argument is supported with the results of some previous studies which concluded that the successful implementation of sophisticated accounting techniques may not only be related to implantation-related factors but also to more general contingent factors related to the organization characteristics and its environment (Tillema, 2005).

7 6-An overview for the developed theoretical model Drawing on the premise of the previous contingency- based studies in management accounting in general and VBM in specific, a comprehensive contingency based model for VBM using Structural equation modelling has been developed in order to achieve the research objectives. The contingency approach to management accounting is based on the basic notion that there is no universally appropriate accounting system that is applicable to all organizations under any circumstances.alternatively, the characteristics of the appropriate accounting system depends on the context and the circumstances in which an organization operates and the effectiveness of the system depends on the appropriate fit between the design of the system and the contextual factors (Haldama and Laats,2002). On this model, it is argued that there are at least three groups of contingent variables that determine the effectiveness of VBM. First, agency cost resulting from the separation between ownership and management. It has been argued that implementing VBM approach can protect the owners of companies from this possible conflict and better align the interests of owners and management. In addition, it is expected that the higher the agency cost the better the corporate governance practices that the company adopt as another means to minimize agency cost. Second, external environmental characteristics motivate the management to work on the best interests of owners, for Example, threat of takeover, influence of consultants and the less uncertain environment. Third, organizational characteristics which suggest that VBM best suit large size organizations, organizational structure where managers have a high level of autonomy over value-creating decisions and technologies that are more highly automated with low task uncertainty. Moreover, this model suggests that the proper fit between the design of VBM and

8 the contingent variables can improve both of performance and the adopted corporate governance practices which in turn lead to improvements in organizational performance. Agency cost Size Ownership structure -Management ownership -Institutional shareholders Financial Leverage Growth opportunities Corporate Governance Board of directors -Size -Non-exec.Directors -Independence -Duality Audit Committee -Usage -Independence External Characteristics Threat of Takeover Management Consultants Environmental Uncertainty VBM Usage

9 Organizational Characteristics Strategy Technology Organizational structure Organizational Life cycle Organizational Performance Figure (1) the research theoretical model 7-Research Method To answer the research question, this study is planned to apply a survey of two matched samples from the UK companies.the first sample represents companies that adopt VBM and the second sample represents companies that don t adopt the VBM. To determine which companies could be included in our sample we can use the published public data, surveys of the consulting groups and the pilot work by visiting those companies.the

10 research data is to be collected basically through analysis of documents and published public information beside a questionnaire targets CFO and controllers, complemented by semistructured interviews, elements of observation in order to ensure some element of triangulation. The comparison between the two samples will include comparing the performance results using some financial measures. In additional to, comparing the corporate governance practices in terms of the extent to which the companies comply with the principles of the combined code of governance in the UK. Refrences: Biddle, G., Bowen, R., Wallace, J., (1997). Does EVAs beat earnings? Evidence on the associations with stock returns and firm values. Journal of Accounting and Economics 24, Busco, C., Frigo,M., Giovanni, E., Riccaboni, A., and Scapens, R. (2005).beyond compliance:an integrated governance framework. London: Institute of chartered accountants in England and Wales.

11 CIMA/IFAC, (2004).Enterprise governance: getting the balance right. Charter Institute of Management Accountats. CIMA (2004).Maximizing shareholder value, achieving clarity in decision- making.tecnical report, Charter Institute of Management Accountats. Dodd, J. L. and Chen, S.,(1996) EVA: a new panacea?, Business and Economic Review, Vol. 42, no. 4, pp Fahi, M., Roche, J., Weiner, A.,(2005). Beyond governance, creating corporate value through performance, conformance and responsibility. John Wiley & Sons, Ltd. Haldama, T., Laats, K., Contingencies influencing the management accounting practices of Estonian manufacturing companies. Management Accounting Research, 13, Haspeslagh,P., Noda,T.,Boulos,F.(2001).Managing for value :it s not just about the numbers,harvard Business Review, july-august, Hogan,C.E,Craig,M.L.(2001).long run performance of firms adopting compensation plans based on economic profits. SSRN working paper. Ittner,C.,Larcker,D., (2001). Assessing empirical research in managerial accounting : a valuebased management perspective. Journal of accounting and economics, 32, Lehn, K., Makhija, A., EVA, accounting profits, and CEO turnover: an empirical examination, Journal of Applied Corporate Finance 10, Stewart, G.B.III., The Quest for Value. Harper Business, New York. Tillema, S., Towards an integrated contingency framework for MAS sophistication: case studies on the scope of accounting instruments in Dutch power and gas companies. Management Accounting Research, 16, Wallace, J., Adopting residual income-based compensation plans: do you get what you pay for? Journal of Accounting and Economics, 24,

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