Society for Business and Management Dynamics. Business Management Dynamics Vol.1, No.1, July 2011, pp.85-93

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1 Busness Management Dynamcs Can good boards lead to better frm s performance: Evdence from publc lsted companes n man Board Bursa Malaysa Norza Mohd Saad 1, Wan Mohammad Taufk Wan Abdullah 2 Abstract Corporate Governance (CG) has ts own code of best practces that should be comply by every lsted company n the world. Ths study wll gve more understandng of why company should comply wth the code of CG where the fndng reveal that exst an assocaton between CG complance on board of drectors (BOD) facets wth frm s performance. For the purpose of collectng nformaton on the BOD, ths study used the companes annual reports n year 2004 untl 2006 for 16 lsted companes n man board Bursa Malaysa Securtes Berhad. Annual reports are suffcent for gatherng such data consderng lsted companes must abde to Securtes Exchange Commsson s requrement of such dsclosure whereas the data for the frm s performance was gathered from Thompson DataStream. The ndvdual facets of BOD that are of nterest to us are as follows: () BOD communcaton; () BOD educaton and tranng and () composton of ndependent drectors. Evdently, the company wth good CG complance can maxmze the shareholders wealth by maxmzng ther market value. Keywords:Corporate Governance, Complance, Board of Drector facets, Frm s Performance Avalable onlne SSN: INTRODUCTION Corporate governance has receved ncreasng emphass both n practce and n academc research (e.g., Blue Rbbon Commttee Report 1999; Ramsay Report 2001; Sarbanes-Oxley 2002; Bebchuk and Cohen 2004). Ths emphass s due, n part, to the prevalence of hghly publczed and egregous fnancal reportng frauds such as Enron, Worldcom, Adelpha, and Parmalat, an unprecedented number of earnngs restatements (Palmrose and Scholz 2002; Larcker et. al. 2004) and clams of blatant earnngs manpulaton by corporate management (Krugman 2002). The mportance of the board of drectors arses as a result of the dsperson of ownershp n today s modern corporatons, whch rely heavly on the external sources of captal. Hence, the owners of the frm are no longer the ones responsble for decdng the drecton and the daly operaton of the frm. Rather, the daly operatons of the frm are n the hands of a team of professonal managers who, at best, own a neglgble amount of equty. Ths separaton between ownershp and control n today s modern companes has resulted n a potental conflct of nterest (Berle and Means, 192). The creaton of a board of drectors s to montor the performance of the frms so that the nterests of the shareholders are protected (Kosnk, 1987, 1990; Amercan Law Insttute, 1982). Therefore, t s predcted that f the board performs ts dutes effectvely, the value of the frm s predcted to ncrease and the wealth of the shareholders wll be enhanced accordngly. The queston that remans to be answered s: Do boards of drectors functon effectvely n montorng the performance of the management? If the boards were effectve, t would be predcted that the value of the frm would ncrease. The remander of ths paper s structured as follows. Frst, a lterature revew wll be presented amng at developng testable hypotheses, followed by a secton outlnng the methodology of the research. Subsequently, results wll be presented followed by a secton dscussng the fndngs as well as the conclusons thereof. 1 Unverst Tenaga Nasonal, Kampus Sultan Haj Ahmad Shah, Bandar Muadzam Shah, Pahang, Malaysa. (O) ,(Fax): , Emal: norza@unten.edu.my 2Unverst Tenaga Nasonal, Kampus Sultan Haj Ahmad Shah, Bandar Muadzam Shah, Pahang, Malaysa. (O) ,(Fax): , Emal:

2 Busness Management Dynamcs LITERATURE REVIEW A large body of lterature on corporate governance and corporate performance provdes a bass for ths study. Ths secton attempts to present emprcal studes n ths feld. From the studes made by Bauer, R., Guenster, N. & Otten, R. (2004), ths paper analyzed the relatonshp between dfferent governance standards and stock returns, frm value and operatng performance for frms. When the evdence on the relatonshp between corporate governance and frm value as well as equty s combned, substantal dfferences are found between UK market and the Eurozone market. Whle economcally large excess returns to a zero-nvestment corporate governance strategy n the UK were found, no evdence was found of the relatonshp between governance and frm valuaton. Ths result ndcates that the UK market s stll adjustng. In the long-run, the excess return to corporate governance should translate nto a hgher frm valuaton and better-governed frms. Ths results s n lne wth pror emprcal research dscussed above, whch also demonstrated that the lower the governance standards, the stronger the relatonshp between governance and frm value. In a study conducted by Hermaln, E.B. & Wesbach, M.s.(200), says that several key fndngs have been derved from the emprcal lterature on boards. Notable, board composton s not related to corporate governance performance, whle board sze s negatvely related to corporate performance. In addton, both board composton and board sze do appear to be related to the qualty of the board s decsons on CEO Replacement, acqustons, poson plls, and executve compensaton. Fnally, boards appear to evolve over tme as a functon of the bargan poston of the CEO relatve to what of the exstng drectors. From the performance, CEO turnover and changes n ownershp structure appear to be mportant factors affectng changes to boards. Two characterstcs of board s ther sze and ther composton s concevably correlated wth a board s ndependence. A number of studes found that these characterstcs are assocated wth boards that take better actons from the shareholders perspectve. However, lackng on adequate nterpretaton of these results, they are reluctant to recommend polcy changes on the bass of ths studes. In the Malaysan scenaro, Annuar and Shamser (1994) provded evdence that the change n membershp of the board has no sgnfcant effect on the frms share prce surroundng the announcement date. Abdul Rahman and Hanffa (200) analyzed the relatonshp between board composton and corporate performance of 47 non-fnancal and non unt trusts Malaysan lsted companes coverng the perod , based on market return (Tobn s Q) and accountng returns (ROA and ROE). Ther results show no sgnfcant relatonshp between board composton and both measures of frm performance. Smlarly, the fndngs by Abdullah (2004), based on lsted companes for the perod , also found no assocaton between board ndependence and frms performance. These studes found that the Malaysan companes board of were generally domnated by outsde drectors. In fact, the companes have compled wth the one-thrd requrement well before the publcaton of the report by the Fnance Commttee on Corporate Governance (1999). However, the queston remans as to whether the Malaysan companes boards are actually effectve n ther montorng functon. In explanng the mportance of board educaton and tranng, a study by Molnar, C., Morlock, L., Alexender, J. & Lyles, C. Ac (1992) found the results from the multple regressons ndcate that board tranng s sgnfcant n explanng varous hosptal fnancng vablty outcomes. Thus suggestng that traned boards may be more nformed and better decson-makng and governng bodes than untraned boards. However, the cross-sectonal desgn of ths study precludes rulng out an alternatve explanaton that hosptals better off fnancally have the resources to pay for external educatonal programs foe board members. Thus, ths relatonshp between board tranng and fnancal ratos need longtude examnaton to dentfy the sequencng of these relatonshps. Prevous research done by Pearson, O. S. (2006), the result baser upon logt regresson analyss ndcate that both the ndependence and effectveness of the BOD can help to reduce the lkelhood of the non-fnancal reportng fraud. In partcular, the lkelhood of non-fnancal reportng fraud s lower f the BOD has larger proporton of outsde ndependent drectors, the CEO and BOD charman are not the same person, BOD sze are smaller and the proftablty s hgher. The result regardng outsde drectors supports the recent regulatory reform of corporate governance whch requres majorty f ndependent drectors on the board. The BOD sze result ndcates that smaller board sze s lkely to be more effectve n montorng management. On the other hand, the ethcalstandard result mples that fraud do not necessarly mplement or enforce ethcal standards even when they so stated n wrtng.

3 Busness Management Dynamcs DATA METHODOLOGY Data Samplng The sample of 16 companes from fve dfferent ndustres n the Man Board of Bursa Malaysa from 2004 to 2006 was used. Detals sample was reveal n table 1. Hypothess The null hypothess of the study s developed to cater for the poolng regresson model. The null hypothess s: H 0: There s no relatonshp between frm s performance and all ndependent varables. H 1: There s a relatonshp between frm s performance and all ndependent varables. Insert Table 1 Here Sources of Data All data that we use n ths study are secondary data manly extracted from the companes annual reports. Data on frms performance were obtaned from the Thompson s DataStream. There are two man varables n ths study, dependent and ndependent, and the proxes that represent both varables are shown n table 2. Insert Table 2 Here Regresson Equaton The man objectve of the present study s to examne the relatonshp between corporate governance complance and frms performance. The relatonshp between the BOD facets and frms performance wll be estmated usng the followng regresson equatons: MV ( BC ( BE ( CB (1) PER ( BC ( BE ( CB (2) DY ( BC ( BE ( CB () CG ( BC ( BE ( CB (4) ROCE ( BC ( BE ( CB (5) PR ( BC ( BE ( CB (6) BR ( BC ( BE ( CB (7) Where = the constant term, = the slope or coeffcent estmates of the explanatory varables. RESULTS AND DISCUSSION Analyss of the Implementaton of Corporate Governance among Board of Drector Facets n Man Board Bursa Malaysa BOD Communcaton wth Shareholders Insert Fgure 1 Here The Code of Best Practces n Corporate Governance for Board of Drectors spells out the prncpal responsbltes of the board. In order to effectvely lead and control the company, the board should develop and mplement an nvestor relatons program or shareholder communcatons polcy for the company; and to ensure that the company has n place a polcy to enable the company to communcate effectvely wth other stakeholders and the publc generally. Fgure 1 shows that, the complance level s 98.77% for year 2004 and 2005, and 99.9% for year 2006 respectvely. Only 1.2% for year 2004 and 2005, and 0.61% for year 2006 of the companes dd not comply wth the requrement of the code. We beleved that the hgh degree of complance among companes to ths requrement s due to the requrement of the Companes Act 1965 to conduct the annual general meetng wthn a 60-day perod from the fnancal year ends as well as the Bursa Malaysa Revamped Lstng Requrements whch requres all lsted companes to comply wth the code. Therefore, the actve partcpaton of shareholders n the general meetng wll allow the Board of Drectors to meet wth ther shareholders to explan the company s corporate strateges, current performance, developments and future plannng. The general meetng also enables the Board to receve feedback from ther shareholders and together make decsons for the company. Ths s

4 Busness Management Dynamcs supported by Hartzell and Starks (2001) whch found some changes n real actvtes of the frm subsequent to the shareholders pressure BOD Educaton Program (Tranng) Insert Fgure 2 Here Companes have to ensure that t recruts to the company only ndvduals of suffcent calber, knowledge and experence to fulfll the dutes of a drector approprately. The calber of the board members s of specal mportance n settng and mantanng standards of corporate governance. In order to comply wth ths requrement, all the drectors of companes have to attend the Mandatory Accredtaton Program (MAP) conducted by the Research Insttute of Investment Analysts Malaysa (RIIAM). In addton, all drectors wll endeavor to fulfll the requrement of Contnung Educaton Program (CEP) wthn the stpulated tme frame as set by the Bursa Malaysa Securtes Berhad n order to enhance the effectveness of the drectors n dschargng ther dutes. Fgure 2 shows that 87.7% of the companes n Man Board of Bursa Malaysa have sent ther drectors to the tranng program n the year under study and 12.27% of the companes do not sent ther drectors to the tranng program. We are n the opnon that most of the companes are aware on the mportance of drectors tranng whch s beleved wll contrbute postvely to the frms performance. Ths s supported by Molnar, C., Morlock, L., Alexender, J. & Lyles, C. Ac. (1992), whch specfes that the results from the multple regressons ndcate that board tranng s sgnfcant n explanng varous hosptal fnancng vablty outcomes BOD Composton (Independent Drectors) Insert Fgure Here As stated n the Malaysan Code on Corporate Governance (the Code), every companes lsted must have at least one-thrd number of ndependent non-executves n the Board of Drectors (BOD). The Independent Drectors brng to bear objectve and ndependent judgment on varous ssues dealt wth at the BOD. Fgure shows that the percentage of the companes whch comples wth the one-thrd number of ndependent drectors of the boards requrement n 2004 s 84.66% and the balance of 15.4% do not comply. The percentage of complance ncreased up to 89.57% n However, the percentage was slghtly decreased n 2006 to 88.4%. The result shows that those companes whch comply wth the one-thrd of ndependent drectors have shown an mpressve frms performance. They have mproved the busness operatons and performance and corporate strateges. Ths fndng s supported by the prevous studes by Hermaln and Wesbach (200) whch found that the board composton has a postve and statstcally sgnfcant effect on frm s effcency. In another study by Klen, et al.(2005) revealed that, the board composton, ownershp and shareholdngs have a sgnfcant mpact on frms performance. Analyss of the Relatonshp between all the Dependent and Independent Varables. Result n the table shows that there are sgnfcant relatonshps between BOD Educaton and Composton of BOD (ndependent varable) wth the dependent varables. The BOD Educaton has postve relatonshp wth dvdend yeld (DY) at 0.002*** sgnfcant level wth T-Rato at.094, return on captal employed (ROCE) at 0.009*** sgnfcant level wth T-Rato at 2.66, and payout rato (PR) at 0.000*** sgnfcant level wth T-Rato at.719. On the other hand, the Composton of BOD has negatve relatonshp wth market value (MV) of the frms at 0.084* sgnfcant level wth T-Rato at If we look at the value of R-Square, these ndcates that 0.7% for market value (MV), 0.% for prce earnng rato (PER), 2.1% for dvdend yeld (DY), 1.0% for captal gearng, 1.8% for return on captal employed (ROCE), 2.8% for payout rato (PR) and 0.5% for borrowng rato (BR). Hence, these small amounts of R-Square explaned by Corporate Governance ndcate varatons to each varable. Ths s supported by the study by Che Haat (2006) whch found that a sgnfcant negatve relatonshp between board composton and market performance whch ndcates that nvestors do not rely on frm s nternal governance. Insert Table Here

5 Busness Management Dynamcs Pearson Correlaton Analyss Table 6 shows the correlaton analyss for all varables nvolved n the study. The results suggest that dvdend yeld (DY), return on captal employed (ROCE) and payout rato (PR) was sgnfcantly correlated at 0.0 levels (2-taled) wth BOD Educaton (ndependent varable). Estmated the Pearson product-moment correlaton s 0.18**, mplyng a postvely correlated relatonshp wth a magntude of 1.8% between the two varables of dvdend yeld (DY) and BOD Educaton. For the return on captal employed (ROCE), the correlaton s 0.121** and t mples a postve correlated relatonshp wth the magntude of 12.1% wth BOD Educaton. Payout rato (PR) has a postve correlated relatonshp wth BOD Educaton at 0.167** and wth the magntude of 16.7% respectvely. Ths means, the null hypothess should be rejected at 0.01(1%) levels of sgnfcant. It s also found that there s a strong postve relatonshp wth ndependent and dependent varables. As for the correlaton between BOD Communcaton and Composton of BOD wth market return, t was found that both of the board ndependence was not assocated wth market return as ndcated by ts statstcally nsgnfcant correlaton coeffcent wth all the dependent varables. Besdes, there s a postve and sgnfcant correlaton between BOD Educaton and dependent varables. It can be suggested that BOD Educaton s assocated wth the frm s market value. So, those companes who comply wth the code of Corporate Governance tend to perform better rather than not. Insert Table 4 Here CONCLUSION AND RECOMMENDATION The objectve of ths study s to dentfy the complance level among publc lsted companes wth the code of corporate governance and to scrutnze whether there s any relatonshp between corporate governance and frm performance. Based on the results for the past three years (2004, 2005 and 2006), the studed has a postve relatonshp among BOD communcaton, negatve relatonshp between dependent and BOD educaton and no relatonshp among composton of BOD. Majorty of the company compled well wth the code of corporate governance to get better performance nclude MV, PER, DY, CG, ROCE, PR and BR for ther company. Most of the companes compled well wth the MCCG because they have sent ther board of drectors to go to the tranng program before they take the board postons. The result shows that BOD educaton s the most mportant and gves benefts to the companes. Besdes, BOD communcaton and composton of BOD are also mportant to the company because f there were not dsclosed ther level of communcaton wth shareholders, board of drectors cannot get feedback from ther shareholders and unable to ncrease the confdence level among them. If there were no well structured of composton of BOD, how should the company been well organzed. Supported evdence to ths concluson was sayng that corporate governance has been dentfed n prevous studes to nfluence the captal structure decsons of frms. The studes dentfed the man characterstc of corporate governance whch nclude board sze, board composton, CEO dualty, tenure of the CEO and CEO compensaton. The studes are from Berger at al., 1997; and Frend and Lang (1988). Lpton and Lorsch (1992) also fnd there s sgnfcant relatonshp between frm s performance and board sze. From these overall studes, t can be recommended that all companes should comply wth the code of corporate governance. It s because t was proven by ths study that the code have a lnk wth the frm s performance. Companes should take those opportuntes that have been gven by Bursa Malaysa Securtes Berhad (BMSB) for the purpose of helpng drectors organze and cooperate wth ther company. They should take ths opportunty by sendng or appont two or more drectors to go for tranng program so that they can easly update or gan more nformaton about how to mantan or develop company s performance and develop ther own leadershp sklls. Companes that dd not comply wth the requrement of corporate governance by havng one-thrd of ndependent drectors should try to acheve the requrement. If not, ths wll gve some effect to the company even though drectors cannot recognze t. Lastly, by complyng wth to code of corporate governance they can attract more shareholders or nvestors to nvest n ther company and concdently can gan market return. Besdes, they can easly expose ther company s name n Bursa Malaysa.

6 Busness Management Dynamcs REFERENCES Abdullah, Shamsul N. (2004). Board Composton, CEO Dualty and Performance among Malaysan Lsted Companes, Corporate Governance The Internatonal Journal of Busness n Socety, Vol. 4, No. 4, pp Abdul Rahman, R and Roszan Mohd Hanffa (200), Internal Governance Mechansms and Performance of Malaysan Lsted Companes. A Paper presented at ANZAM Conference, Australa. Abor, J. (2007). Corporate Governance and Fnancng Decsons of Ghanaan Lsted Frms. Q Emerald Group Publshng Lmted, Vol. 7(1), pp8-92. Annuar, M.N. and Shamsher, M. (1994). The Wealth Effect of Appontments and Resgnatons of Board of Drectors, The Malaysan Management Revew. Vol. 29, No. 2, pp: Amercan Law Insttute. (1982). Prncples of Corporate Governance and Structure: Restatement and Recommendatons.: Amercan Law Insttute, New York, NY. Bauer, R., Guenster, N. & Otten, R. (2004). Emprcal Evdence on Corporate Governance n Europe: The Effect on Stock Returns, Frm Value and Performance. Journal of Asset Management. Vol. 5(2), pp Bebchuck and Cohen The Costs of Entrenched Boards. Workng Paper. Harvard Law School. Berle, A. Means, G. (192), The Modern Corporaton and Prvate Property, MacMllan, New York, NY. Blue Rbbon Commttee Report and Recommendatons of the Blue Rbbon Commttee on Improvng the Effectveness of Corporate Audt Commttees. New York Stock Exchange and Natonal Assocaton of Securtes Dealers. Che Haat, Mohd Hassan (2006). Corporate Governance, Transparency and Frm Performance, A Thess at Faculty of Accountancy, Unverst Teknolog MARA, Shah Alam, Malaysa. Fnance Commttee of Corporate Governance (1999). Report on Corporate Governance, Mnstry of Fnance, Malaysa. Frend K. and K. Lang (1988). An Emprcal Test of the Impact of Manageral Self Interest on Corporate Captal Structure. Journal of Fnance 4, pp Hartzell, J. C. and L.T. Starks (2000). Insttutonal Investors and Executve Compensaton, Workng Paper New York Unversty and Unversty of Texas at Austn. Hermaln, E.B. & Wesbach, M.s. (200). Board of Drectors As an Endogenously Determned Insttton: A Survey of the Economc Lterature. Economc Polcy Revew, Vol. 9(1), pp Klen, Peter, Shapro, Danel and Young, Jeffrey (2005). Corporate Governance, Famly Ownershp and Frm Value, Corporate Governance An Internatonal Revew, Vol. 1, No. 6, pp Kosnk, R.D. (1987). Greenmal: A Study of Board Performance n Corporate Governance. Admnstratve Scence Quarterly, Vol. 2 No. 2, pp Kosnk. R.D. (1990). Effects of Board Demography and Drectors Incentves on Corporate Greenmal Decsons. Academy of Management Journal, Vol. No.1, pp Krugman, P The Insder Game. New York Tmes (July 12). Larcker, D., S. Rchardson and I. Tuna Does Corporate Governance Really Matter? Workng paper, The Wharton School. Molnar, C., Morlock, L., Alexender, J. & Lyles, C. Ac., (1992). Hosptal Board Effectveness: Relatonshps Between Board Tranng and Hosptal Fnancal Vablty. Health Care Management Revew, Vol. 17(), pp4-49. Palmrose, Z. and S. Scholz The Accountng Causes and Legal Consequences of Non-GAAP Reportng: Evdence from Restatements. Contemporary Accountng Research Conference. (November). Pearson, O. S., (2006). Corporate Governance and Non-Fnancal Reportng Fraud. Journal of Busness and Economc Studes, Vol.12(1), pp Ramsay, Ramsay Report. Independence of Australan Company Audtors: Revew of Current Australan Requrements and Proposals for Reform. http// Sarbanes, P., and M. Oxley Sarbanes-Oxley Act Washngton, DC: U.S. Congress. The Busness Roundtable Prncples of Corporate Governance. Washngton, D.C.,

7 Table 1: Number of Company wthn Industry Industry No. of Company Busness Management Dynamcs Sample Sze (0% of the Companes) Consumer Product Industral Product Tradng and Servces Propertes Plantaton 44 1 TOTAL Table 2: Dependent and Independent Varables Varables Proxes Dependent - Market Value (MV) - Borrowng Rato (BR) - Prce Earnngs Rato (PER) - Payout Rato (PR) - Dvdend Yeld (DY) - Captal Gearng (CG) - Return on Captal Employed (ROCE) - BOD Communcaton (BC) - BOD Educaton (BE) - Composton of BOD (CB) Independent Fgure 1: The Communcaton of BOD wth the Shareholders. Fgure 2: Educaton Program or Tranng of the Drectors.

8 Busness Management Dynamcs Fgure : Composton of Independent Drectors n the Company Table : Regresson Analyss Results R Square: MV=0.007, PER=0.00, DY=0.021, CG=0.010, ROCE=0.018, PR=0.028, BR=0.005; Dependent BOD Communcaton Independent Varables BOD Educaton Composton of BOD Varables T-Rato P-Value T-Rato P-Value T-Rato P-Value MV *0.084 PER DY *** CG ROCE *** PR *** BR *Sgnfcant level at 0.1(10%), **Sgnfcant level at 0.05(5%) and ***Sgnfcant level at 0.01(1%) Table 4: Results of Pearson Correlaton Analyss among Varables BC BE CB MV PER DY CG ROCE PR BC 1 BE CB MV

9 PER *- DY ** CG ** ** Busness Management Dynamcs **- ROCE 0.00 ** * PR ** **0.507 **-0.20 ** **- BR ** ** **