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Int Entrep Manag J (2013) 9:59 75 DOI 10.

1007/s11365-011-0209-9

Board of directors effects on financial distress evidence of family owned businesses in Lebanon
Charbel C. Salloum & Nehme M. Azoury & Tarek M. Azzi

Published online: 22 October 2011 # Springer Science+Business Media, LLC 2011

Abstract The objective of this paper is to determine the managerial governance characteristics related to financial distress companies. The boards failed to accomplish their monitoring duties, which seemed to be one of the main reasons behind the actual financial distress and bankruptcy that swept the companies across the planet. Through the analysis of a sample of 178 Lebanese non listed and owned family firms, the results showed that the boards (that have a higher proportion of outside directors) are less inclined to face a financial distress than the boards with a lower proportion. Besides, a different conclusion proves that the boards size and financial distress are directly linked. The paper highlights the extent to which financial distress is associated with corporate governance from a Euro Mediterranean country. It would be a source of education to Lebanese investors who excessively go for short-term returns and of help for regulatory authorities in the framework of making policies on corporate governance reformation. Keywords Financial distress . Corporate governance . Board of directors and bankruptcy

Introduction Following the world financial scandal of corporate giants, the boards of directors have been accused of not doing their jobs in a proper and efficient way. Thats why the corporate governance reforms were established, in order to improve the corporate
C. C. Salloum (*) : N. M. Azoury : T. M. Azzi Faculty of Business Administration, Holy Spirit University of Kaslik, Kaslik, Lebanon e-mail: salloum@usek.edu.lb N. M. Azoury e-mail: nehmeazoury@usek.edu.lb T. M. Azzi e-mail: tarekazzi@usek.edu.lb

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boards performance (Salloum and Azoury 2009). During the political crisis that ravaged the Middle East between 2004 and 2010, several Lebanese non-listed firms that supposedly used over-leveraging and over-investment were subject to financial distress. The market manipulations led these firms to establish wholly owned subsidiaries in order to buy equities from familys corporate. Besides, the shareholders pledged their assets to financial institutions with a view to raise the funds needed for this operation. Afterwards, they would take hold of the capital gains in case the political crisis is resolved. But if, on the contrary, the political crisis aggravates, the shareholders would take corporate funds to avoid the sale of the assets by the financial institutions. At this level, these firms will undoubtedly face a financial distress. Furthermore, Lebanese financial analysts, investors and accounting professionals, are constantly trying to find warning signs of financial distress. In this context, this study intends to analyze the relationship between corporate governance and financial distress. Lee and Yeh (2004) examined ownership structures (such as equities held) and board composition (such as board seats), forgetting about other governance characteristics (such as outside directors and female directors on the board) on which financial performance might rely. Therefore, this paper seeks to associate full or robust characteristics to the probability of financial distress. Consequently, the corporate governance model structure aiming at improving corporates performance and avoiding financial distress will be developed. This paper will be presented as follows: on the first hand, we will present a literature review and relevant hypotheses. On the other hand, we will establish the adopted methodology approach. Finally, we will discuss our results and conclusions.

Background and hypothesis development Research context The Middle East is a growing, lucrative marketplace that has recently captured the interest of the world for political as well as economic reasons due to the War in Iraq, which began in 2003. Since the discovery of oil in the Gulf Region in the 1930s, the Middle East has been in transition. The population of the Middle East has grown very fast in the past 30 years faster than any other region of the world except subSaharan Africa. The subsequent increases in revenue have resulted in drastic changes and significant industrialization within these countries. Contact with Western countries and corporations improved the standard of living in the Middle East through better education, improved health care, greater mobility, and increased communication (Ali 1993). Lebanon has been considered a vibrant market economy since ancient times, when the Lebanese, then called the Phoenicians, were the first to start commercial transactions. The country is well known for its marketing prowess and its educated and talented population. Before the 1970s, Lebanons per capita income was similar to that of Southern Europe (Fahed-Sreih 2006), and the country was a commercial center for the entire Middle East. Recent events, however, have undermined Lebanons historically healthy economy. A twenty-year civil war seriously damaged Lebanons infrastructure and cut its GNP output by almost half. After the war ended in 1991, Lebanons main

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growth sectors were tourism and banking. After the September 11, 2001 attacks, Lebanon was considered by the Arab world to be a safe place for deposits, as it practices banking secrecy and was no longer at war. Israeli occupation from 1978 to 2000 and Syrian occupation from 1978 to spring 2005 have left Lebanon with massive political and financial problems to solve, including physical and social infrastructural reconstruction. The unanticipated 34-day Israel-Hezbollah war in July 2006 further devastated the Lebanese economy. It is believed in Lebanon and the Arab world, more than anywhere else in the world, that family businesses, rather than being a moneygenerating activity or a market-driven pursuit, are a way to enhance a familys social standing (Fahed-Sreih 2006). Lebanese family businesses are the engine that drives socioeconomic development and wealth creation, and entrepreneurship is a key driver of family businesses. This special way of managing a business in Arab countries relates to the socioeconomic and cultural backgrounds of these families (Ali 1993). Lebanons corporate governance Corporate governance in Lebanon is not yet well developed, but in the last few decades the government has taken some steps to make marginal improvements. Existing legal and regulatory requirements lack many important corporate governance protection codes, especially with respect to the composition and operation of boards of directors. The Lebanese economy is dominated by familyowned businesses that do not support transparent corporate culture and protocol, which in turn define the roles and responsibilities of those charged with conducting corporate decisions. Lebanons experience with corporate boards and their effectiveness as a control mechanism are not well known because of the lack of transparency. Separation of ownership and control has not yet been fully realized. The commercial code, specifically Article 153, does not provide for the separation of the roles of the chairman of the board from those of the general manager: the boards chairman is responsible for executing the duties of the general manager unless he/she appoints one on his/her behalf. The concept of truly independent outside directors does not seem to have been utilized yet. The commercial code does not provide for a clear and enforceable definition of an independent outside director to guarantee board independence. The code only requires boards to have a minimum of three directors. The law does not provide adequate protection of shareholders rights or equitable treatment. A company is not legally obligated to share in company profits with shareholders or to provide shareholders with complete disclosure of company information. The law only obligates firms to disclose corporate charters along with information related to equity holders, their aggregate holdings, and shareholder meetings to the Commercial Register. Firms are also required by law to disclose budget-related information to the Ministry of Finance. However, it is not easy to access such information: first, the law does not obligate governmental agencies to disclose company information to anyone; and second, the process of searching for needed company information is time consuming as it involves going through piles of related paper documents. Families control a majority of Lebanese companies, either through complex pyramid structures or through ownership of a majority of outstanding voting shares. Pyramid structures allow families to gain control of a number of holding companies and

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subsidiaries through ownership of a small equity percentage in each business. Under Lebanons Commercial Law, companies can issue shares with unequal voting rights, thereby allowing families to control companies by owning a minor economic interest in the business. Family owners have often-valued unrestricted control over their companies more than they have valued higher profits and finding the least expensive form of finance. The main drawback of family-owned businesses is the lack of independence and objectivity needed to monitor the companys activities, which for example could lead to misappropriation of shareholder revenues by the controlling shareholder. Family control does not always result in bad governance. Although the correlation between corporate governance and firm performance is still not clearly established, it is common business practice for firms to establish a board of directors to monitor business performance, thereby protecting the companys shareholders (Kosnik 1990). In addition, the dynamics and development of the corporate economy in developing countries is often different from those in countries with more developed economies. Despite the limited empirical evidence of the role of the board of directors in Lebanon, we attempt to shed light on how the corporate structure faces financial distress. This paper seeks to highlight the existing relationship between corporate governance and financial distress (dependent variable). To that end, we will focus on six main factors of corporate governance (independent variables): 1) outside/independent directors presence on the board, 2) CEO-board chair duality, 3) insiders equity, 4) female directors service on board, 5) the size of the board, 6) the time period of the director served on the board. If some of these characteristics are proved to be significant, firms and governance experts will thus use it as a warning, predicting therefore a situation of financial distress. If not, they will have to analyze the directors unethical behaviors and the power dynamics of the board to explain the financial distress causes. Literature review According to Baldwin and Scott (1983, p. 505), when a firms business deteriorates to the point where it cannot meet its financial obligations, the firm is said to have entered the state of financial distress. The first signals of distress are usually violations of debt covenants coupled with the omission or reduction of dividends. Whitaker (1999) defines entry into financial distress as the first year in which cash flows are less than current maturities long-term debt. As long as cash flow exceeds current debt obligations, the firm has enough funds to pay its creditors. The key factor in identifying firms in financial distress is their inability to meet contractual debt obligations. However, financial distress symptoms are not limited to firms that default on their debt obligations. Substantial financial distress effects are incurred well prior to default. Weisbach (1988) depicts a process of a financial distress that begins with an incubation period characterized by a set of bad economic conditions and poor management who commit costly mistakes. Weisbach (1988) argues that firms enter financial distress as the result of economic distress, declines in their performance and poor management. In our literature review, poor performance will be measured by a coverage ratio (defined as EBITDA/Interest Expenses). The theoretical linkage between corporate governance and financial distress originates from organizational theory literature. In declining or crisis periods,

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organizations often engage in a mechanistic shift, from which centralization of authority is the most widely recognized outcome (Daily and Dalton 1994). These authors also argue that centralized authority has particular applications to the relationship between governance structure and bankruptcy. The issue of centralization of authority is applicable to the agency problem. It may be characteristic of firms in persistent financial distress to have weak corporate governance, as measured by board composition and structure. Hermalin and Weisbach (1988) supposed that the number of independent directors could increase on the board as a result of poor performance. Moreover, Baysinger and Butler (1985) considered that a high proportion of outside directors could lead to a better performance According to the authors; this proportion keeps declining through the CEOs career. In conclusion, poor performance seems to be due to boards with few independent directors. On the other hand, Salloum and Azoury (2009) mentioned that various Lebanese firms establish formal board committee that is assigned to monitor corporate disclosure. There has been little progress in improving Lebanese Board functions. Most boards have few nonexecutive directors and even fewer independent directors. Boards tend to play a passive role in reviewing management performance or in strategic planning. Nomination, compensation, or audit committees are rare. An insider-dominated board may be a potential explanation of distress in Lebanon. Outside directors more likely guaranty transparency because of their position and independence. According to Baysinger and Butler (1985), boards are not involved in the process of decision making when there are a high proportion of insiders. In fact, they do not have the right to monitor the CEO. In that case, top management is dominating the board of directors, which causes collusion, and transfer of stockholder wealth (Baysinger and Butler 1985). Pfeffer (1972) also found that the boards of declining firms have a high percentage of insider directors. In the context of financial distress, the distressed firms seem to have boards with low proportion of outsiders. Baysinger and Butler (1985) have also indicated that the board composition influences financial performance. This means that financial distress could be due to an insiderdominated board. Based on this theoretical framework between financial distress and board of directors composition and structure, it is hypothesized that: H1: A board with a smaller percentage of outside directors is positively linked to financial distress. Through the analysis of accounting based measures of ROE, ROI and profit margin, Rechner and Dalton (1991) noted that the firms that did not join the CEO and the chairman position exceeded the other firms. In fact, when the firm is bringing together these two positions, it is ruining two of its most important power dynamics (Jensen 1993). The CEO, who is also the board chair, cannot be monitored due to his power, which allows him to take decisions for his own interests while neglecting the shareholder s. Elloumi and Gueyie (2001) asserted this evidence by analyzing financially distressed firms. Moreover, Daily and Dalton (1994) found that these firms are more subject to bankruptcy in a particular way. The same applies to Salloum and Azoury (2009) who examined a sample of 71 non-listed Lebanese firms. CEO duality is a common structure in Lebanon and relate to prestige and recognition status in the Lebanese society. Most of these types of Lebanese firms

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usually face kind negative operating income due to expenses related to non-firms activities and based on inappropriate extortion of firms funds. Thus, several results related to the relationship between CEO duality and corporate failures saw the light. Therefore, financial distress can be explained through the fact that CEO and chairperson of the board of directors are combined in one position. Based on this theoretical framework between financial distress and CEO duality, the hypothesis takes thus the following form: H2: A firm with the CEO duality is positively correlated with financial distress. Jensen and Mecklings (1976) considered for their part that firm performance depends on the insider s ownership (as top-managements shareholders), knowing that it rises accordingly. In fact, insiders do not divert resources that are dedicated to the optimization of shareholders value. According to Chen et al. (2003) for Japan, insider ownership is positively linked to firm performance. In UK, Davies et al. (2005) found that insider ownership is determined with firm value. For Switzerland, Beiner et al. (2006) also considered that insider ownership positively affects firm value. As for Germany, Kaserer and Moldenhauer (2008) noted that high insider ownership leads to a better performance and less chances of financial distress. In Lebanon, Salloum and Azoury (2009) shed light on the existing connection between inside ownership and financial distress of non-listed firms. In Lebanon class share structures has an unequal voting right. The protection of minority shareholder rights is the key to improving corporate governance in Lebanon. Gilson (1990) considered for his part that the modifications that might target the board composition and the inside equity ownership could probably lead to financial distress. In conclusion, it seems that insider ownership is well influential. Consequently, financial distress could definitely be justified by the small insider s ownership. According to this theoretical framework between financial distress and insiders ownerships, the hypothesis is thus as follows: H3: The smaller the equity ownership held by insiders, the greater the probability of financial distress. The study conducted by Burke (1994) in Canada revealed that about half of the CEOs/board chairmen would rather choose female directors. In fact, they consider that female directors urge the boards to get adapted to drastic changes that affect firm performance, such as unstable impulsive markets, increasing international competitive pressures and new and complex technologies. Van der Zahn also noted a link between female directors in South Africa and firm performance. Besides, female directors positively affect firm value over time. In Japan and Australia, a study was recently conducted, revealing a relationship between female directors, firm performance and financial distress (Bonn et al. 2004). In Spain, Campbell and Minguez-Vera (2007) suggested that the stock market is also affected by the appointment of female directors because investors and potential partners believe that female directors contribute to the improvement of firm value. In a sample of 71 Lebanese firms, Salloum and Azoury (2010) found that financial distress is not the result of the female directors on the boards, which does not explain financial distress. Lebanese directors are motivated by the need for achievement, flexibility in their lives, and the desire for family security. Around 10% of Family owned Business in

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Lebanon is managed by women due to succession of heritage. Resources in Lebanon are managed differently by gender; the masculine approach to resources is to find ways to obtain and use them by leveraging rather than sacrificing the owner s resources. The feminine approach is more personal; the individual is fully at risk and makes a deeper personal commitment to both the opportunity and the resources, including employees. Females tend to encounter greater barriers than males in obtaining business credit. They tend to be more risk averse than males, thus taking on smaller loans. They perceive and approach business differently than men. Thus, according to this theoretical framework between financial distress and female director nomination, the hypothesis is thus as follows: H4: A firm with female director is negatively linked to financial distress. According to Jensen (1993), larger boards are efficiently incapable of monitoring top management. They also cause financial distress. After observing firms in Finland and Eisenberg et al. (1998) concluded that low performance is negatively associated to large boards. Based on firms in Singapore and Malaysia, Mak and Kusnadi (2005) suggested that board size and firm performance are also well linked. Lipton and Lorsch (1992) considered that large boards are not as effective as smaller boards. In fact, a larger board impedes the coordination, which prevents boards from participating in strategic decision-making. Yermack (1996) supports this argument through empirical evidence. Salloum and Azoury (2010) considered for their part that financial distress status highly depends on board size; larger boards could lead to financial distress. Lebaneses board sizes are usually tended to be larger than normal. Being a member of the board is usually associated to prestige and recognition only without any effectiveness or added value because its the CEO or the founder that takes all decisions within the firm. They usually are political and militia members. In fact, the firm is unable to benefit from the expertise and services of the directors on the board if it is too large. In this framework, there are actually many findings related to the link between board size and corporate failures. In conclusion, large board size could justify the financial distress status. Based on this theoretical framework between financial distress and large board size, the hypothesis is thus as follows: H5: A firm with larger board size is positively correlated with financial distress. Short tenure directors and longer tenure directors do not have the same firm knowledge. Thus, they are unable to act in favor of the equity owners interest. According to Stewardship, executives should be stewards taking care of the shareholders interests (Donaldson and Davis 1989). They should also preserve and maximize their wealth with the help of firm performance. Consequently, the stewards functions are well improved (Davis et al. 1997). Furthermore, shorter tenure directors are not well experimented, which explains the financial distress of their firm. In this context, Salloum and Azoury (2009) analyzed a sample of 71 Lebanese owned family firms and concluded that boards of 12 years could also lead to financial distress, considering that the board members lacked monitoring and intellectual capital use. Thus, the authors qualified Lebanese directors as passive. The tenure of a director on board could represent one way to measure his stewardship. In this paper, the number of directors that have served on the board for

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longer than 9 years is used to measure the variable because 9 years is the average period in which a director is appointed in the Lebaneses public sector. H6: The shorter a director has served on a board, the greater the probability that the firm on which he or she serves has financial distress status.

Research method The Lebanese Republic provides a unique living laboratory in which to explore family business development. Although there is an emerging body of knowledge about entrepreneurship and private-enterprise development, there are few in-depth empirical investigations. Firms in Lebanon have gone through harsh years of war and survived, despite the heavy shelling and uncertainties facing their businesses and the country at large. Given the turbulence in the country in recent decades, it comes as no surprise that Lebanon has low scores when it comes to economic performance. Consequently, researchers have a unique opportunity to identify, probe, and analyze the characteristics of family businesss corporate governance while facing financial distress. The sample used in this study consists of 178 family business firms (SMEs with an average of 133 employees), 89 of which are in financial distress because they have experienced negative operating income between 2004 and 2008. Each of the financially distressed firms is matched with a healthy firm, creating a choice-based sample of 89 distressed and 89 healthy Lebanese firms. The database of this research includes owned family business with lack of loan principal/interest payments and bankruptcy. In order to extend the research, the study used the annual reports related to these companies and addressed a questionnaire about the financial distress causes. We were able it identify 200 firms that fell into a financial distress. We then eliminated the firms that were taken over, and got 89 financially distressed firms. We paired each financial distress firm with a nonfinancial distress firm by using codes and firm size. Afterwards, we make sure that non-financial distress firms did not experience any financial distress during the elaboration of this study. We limit our research to firms that only experienced financial distress between 2004 and 2008. All corporate governance variables for financial distress and non-financial distress firms are measured starting from the year (2003) prior to the studied period (20042008). A questionnaire survey was addressed to important persons in top management who knew which information were needed. The respondents were family members and CEOs (founders and successors). It allowed us to collect all the corporate governance variables. For firm size, we used market debt value, number of employees, and asset size to both groups. For industry effects, we also matched each financial distress firm with a non-financial distress firm, with the same first two digits of the code so that we could do a paired firm analysis (Table 1). The majority of companies in Lebanon are small and medium enterprises (SMEs) employing less than 150 employees. The few large companies that do exist tend to have dominant market positions making it difficult for new entrants to establish themselves. Almost 60% of the firms were corporations or LLCs. Only 50% of the entrepreneurs indicated they had originated their enterprises, while approximately

Int Entrep Manag J (2013) 9:59 75 Table 1 Sample selection Sector Initial number 7 6 9 5 24 6 25 13 23 8 8 4 10 6 8 20 6 12 200 Financial distressed firms 4 3 4 2 9 3 13 6 14 3 4 3 3 3 3 8 2 2 89

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Non-financial distressed firms 4 3 4 2 9 3 13 6 14 3 4 3 3 3 3 8 2 2 89

Agriculture Chemical products Construction materials manufacture Cosmetics Distribution Electrical equipment & supplies Financial services Food industry Hospitality industry Jewelry Media & telecommunications Pharmaceutical industry Private contracting industry Publicity & advertisement Publishing & printing industry Services Textile industry Tourism & leisure Total

one-third inherited their business. Family participation was found to be critical. They provide primary sources of start-up capital. Over 50% of the businesses had more than one family investor; 70% had a family member employed full time. This importance of family extends to businesses, where approximately 95% of all private sector companies in Lebanon. It has a long tradition of family dominance over both rulers and business. Historically, companies have relied heavily on retained earnings to fund growth and expansion, with bank financing being the main source of external funding for businesses. Lebanons equity market is relatively underdeveloped compared to other countries in the region. Total market capitalization of the 16 companies listed on the Beirut Stock Exchange (BSE) stood at $3.3 billion at the end of June 2010, about 15% of estimated GDP which is small relative to the regional average of 40% of GDP. A prolonged period of civil unrest and a culture of family ownership of businesses are two of the main reasons for the nascent equity market. The unfavorable business culture in Lebanon constitutes an obstacle to the development of a capital market in the country. The culture that is predominant in the local market is the family-type business culture, which is not favorable for the development of a financial market. Challenges facing the development of a financial market in Lebanon are the lack of central the obsolete technology platform. Afterwards, we make sure that non-financial distress firms did not experience any financial distress during the elaboration of this study. We limit our research to firms

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that only experienced financial distress between 2004 and 2008 (the studied period). All corporate governance variables for financial distress and non-financial distress firms are measured starting from the year (2003) prior to the studied period (2004 2008). A questionnaire was addressed to important persons in top management who knew which information were needed. It allowed us to collect all the corporate governance variables. For firm size, we used market debt value, number of employees, and asset size to both groups. For industry effects, we also matched each financial distress firm with a non-financial distress firm, with the same first two digits of the code so that we could do a paired firm analysis. We conducted a logistic regression analysis in order to evaluate the probability of financial distress. Financial distress score is recoded as 1 for the firm with financial distress; 0 with non-financial distress. This score was modeled as follows: F financial distress 1 1=1 e y And y a0 b1VAR1 b2VAR2 b3VAR3 . . . b8VAR8 Where VAR1-VAR7 is corporate governance characteristics (gender, length of director tenure) and VAR8 is the firm size. For the impact of firms size, we included the firms number of employees as a proxy for the firm size. The variables and descriptions are defined as follows: NOUT CEOD INSO DWO DTO DI9 EPL DEB POUTD Number of total outside directors; Number of CEO duality; Insiders have 0 equity ownership; Directors are women; Total number of directors; Directors over 9 years of tenure; Number of employees; Market debt value in USD; Percentage of directors that are outsiders.

Dependent Variable is whether the firm will face financial distress or not. Financial distress firms are coded as 1 and 0 otherwise. Independent variables include corporate governance characteristics. We defined financial distress with the measure used by Asquith et al. (1994) based on coverage ratio. A firm is considered to be in financial distress if its coverage ratio (defined as EBITDA/Interest Expenses) is less than one for two consecutive years or if it is below 0.8 in any given year. Firms in financial distress are identified with the dummy variable defined below. A dummy variable of 1 and 0 was used to differentiate between financially distress companies and healthy companies. We used a binary variable that equals one (1) for distressed companies and zero (0) for non-distressed companies were used. We used a dummy variable to enable us to use a single regression equation to represent multiple groups. Independent variables include corporate governance characteristics. The market debt value was used instead of the market capitalization for additional information only as the firms value. Table 2 presents the descriptive statistics in the study. Total sample of 178 firms include 89 financial distress firms and 89 non-financial distress firms. It presents

Int Entrep Manag J (2013) 9:59 75 Table 2 Descriptive statistics and correlations for the main variables Variable NOUT CEOD INSO DWO DTO DI9 EPL DEB Sample size 178 178 178 178 178 178 178 178 Minimum 0 0 0 0 4 0 45 211,375,449 Maximum 9 2 3 2 18 5 199 9,311,555,912 Mean 1.45 1.28 .76 .04 8.19 1.39 113.2 4,124,009

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Std. dev. 3.014 1.339 1.234 .282 2.886 3.506 32.418 5,208,113

descriptive statistics for each variable. For example, the average number of female directors for the sample is .04 and the maximum number of female directors for our sample is 2. Table 3 presents the correlation coefficient matrix. Results derived from the Table indicate that multicollinearity among the independent variables is not a problem. Tables 3 and 4 present the results of mean value and mean difference of corporate governance between two groups: Financial distress firms and non-financial distress firms. According to Table 4, three mean differences are significant. These are directors over 9 years of tenure (DIR9), total number of directors (DTO), and percentage of directors that are outsiders (POUTD). Independent samples T test indicate that financial distress firms, on average, have less directors over 9 years of tenure, larger board size, and lower percentage of outside directors than matched non-financial distress firms.

Analysis and results The results of the logistic regression analysis and the interpretation of the hypotheses are presented in this section.
Table 3 Correlation matrix among corporate governance variables NOUT NOUT CEOD INSO DWO DTO DI9 EPL 1 .711 .906 1.323 2.510** 1.312 .414 1 .401 .067 1.628** 0.21 .062 1 .061 .024 .12 .081 1 .038 .037 .022 1 .0997 .083 1 .019 1 CEOD INSO DWO DTO DI9 EPL

The number in the table is t-value. **, *: Significant at .05 and .1 levels respectively

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Table 4 Mean value of corporate governance variables: Financial Distress Firms (1) and Non-Financial Distress Firms (0) Corporate governance DI9 CEOD DWO DTO NOUT INSO EPL POUTD FNF vs. NFDF 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 Sample size 89 89 89 89 89 89 89 89 89 89 89 89 89 89 89 89 Mean 0.28 2.49 1.91 0.65 0.03 0.06 9.24 7.13 0.77 2.13 1.24 0.28 918 1,486 0.02 0.14 Std. dev. 2.298 1.138 1.027 0.409 1.225 1.123 2.054 1.114 2.295 1.579 1.968 1.572 30223.16867 576.754 20067.60443 261.917 0.178 0.827 Std. error 0.953 0.717 0.072 0.222 0.713 0.418 0.339 0.226 0.474 0.304 0.295 0.274 4092 4954 0.106 0.211

This table summarizes the mean values of each variable for both groups

In Table 5, two variables are significant in the models: percentage of outside directors (POUTD) and total number of directors (DTO). Results indicate that firms with a lower percentage of outside directors are more likely to fall into financial distress status and that firms with a large board size are more likely to fall into financial distress status. F financial distress 1 1=1 e y and y a0 b1VAR1 b2VAR2 b3VAR3 . . . b8VAR8
Table 5 Independent samples T test for equality of means Corporate governance CEOD DWO DI9 DTO INSO EPL POUTD Mean difference 1.21 .02 2.07 2.22 .77 4 11 .15 F-statistics .039 .391 1.784 1.712 .226 2.135 11.124 Sig. .72 .187 .038** .012** .307 .257 .002*** T-statistics .352 .501 2.038 2.328 1.038 1.361 3.069

This table compares mean values of corporate governance between two groups: Financial distress firms and non-financial distress firms. Mean Difference is calculated as Financial distress firms (1)nonfinancial distress firms (0). F-statistics, Significance level, and T-statistics are provided. **, ***: Significant at .05 and .01 levels respectively

Int Entrep Manag J (2013) 9:59 75 Table 6 Regression results of the models based on different variables Model 1 INSO DI9 CEOD DWO DTO POUTD EPL Log Likelihood Model x2 .421 .139 .610 .207 2.119** 2.151** .0002 356.40 29.87** 398.21 26.73** .182 .042 .173 2.408** 2.484** .0002 277.51 19.71** 2.329** 2.199** .0002 185.73 18.55** 248.18 11.24** 2.234** .0002 .054 .042 Model 2 Model 3 .319 .254 .151 .112 .158 .238 Model 3 Model 4

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Model 5

2.164**

238.92 19.06**

**: Significant at .05 levels

Where VAR1-VAR7 is corporate governance characteristics (gender, length of director tenure) and VAR8 is the firm size. For the impact of firms size, we included the firms number of employees as a proxy for the firm size (Table 6). A positive regression coefficient means that the explanatory variable increases the probability of financial distress while the negative means that the variable decrease the probability of financial distress. Its a way of describing the relationship between one or more independent variable and a binary response variable (financial distress). As for Modelss equations (multiple regression), we have included and removed additional variables in the 5 models in order to estimate and confirm their effects on the dependent variable as well. H1: A board with a smaller percentage of outside directors is positively correlated with financial distress. The hypothesis is confirmed. Since the number of outside directors varies widely, we standardize this variable by dividing the number of outside directors on a given board by the total number of directors on the board. Since outside directors presumed independence are less subject to CEO control than inside directors, they may be more inclined to press auditors to investigate thoroughly and to test financial results carefully, leading to a reduction in the probability of financial distress. H2: A firm with the CEO duality is positively correlated with financial distress. The hypothesis is not supported. The correlation is insignificant and positive as predicted. The correlation is insignificant and positive as predicted. The duality gives CEO more opportunities to make decisions according to selfinterest or entrenchment-seeking purpose, or he or she may undertake perquisite consumption. The duality would help explain why the correlation is positive. Daily and Dalton (1994) observed that firms with the CEO serving as board chairman are more likely to go bankrupt. Our result is insignificant. The possible explanation is that our data fails to capture the negative effects of the CEO duality on firm performance.

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H3: The smaller the equity ownership held by insiders, the greater the probability of financial distress. This hypothesis is not supported. The correlation is negative as predicted and is insignificant. Since we used a binary approach-share ownership vs. no share ownership-the regression model did not discriminate between large and small insiders. An insider may own ten shares, but this level and value of ownership may be too small to introduce any bias. Nevertheless, equity ownership by insider is often thought to have information content because they had inside information. When their firms are not performing well, insiders will reduce their equity holdings. On the other hand, if their firms as a whole create good performance, they are more willing to hold more equity because the operating income may increase. Or, as we suggest with respect to this hypothesis, whether the firm is associated with financial distress may look into equity ownership held by insiders. H4: A firm with female director is negatively correlated with financial distress. This hypothesis is not supported. The failure to find a correlation could be due to several factors. First, the number of women on board is very limited. The mean is only .04. It might be more revealing to look for a correlation between the percentage of female board members and financial distress. Therefore, we also divide the number of female directors by total directors on the board and re-run the regression. The results are similar: no significant correlation. Having women on the board does not seem to reduce the probability of financial distress. H5: A firm with larger board size is positively correlated with financial distress. This hypothesis is confirmed. Board size and financial distress are positively correlated. Large board is always believed to be an ineffective monitor. As we noted in our discussion of this hypothesis, larger board is associated with lower firm value. This reason results from the inherent problem of inability of large board to control manages. While larger board may have wider discussions on policies of top management, these discussions do not ensure effective monitoring. In the short run, perhaps ineffective monitoring may not cause immediate financial distress. However, in the long run, the accumulated ineffective monitoring may be the trigger of financial distress. Moreover, it has never occurred that a firm with ineffective monitoring can eliminate unethical behaviors of management. Largeness is not an infallible indicator that directors coordinate to confront CEO. H6: The shorter a director has served on a board, the greater the probability that the firm on which he or she serves has financial distress status. He or She serves has financial distress. This hypothesis is not supported. The correlation was insignificant and negative. It is equally probable (or improbable) that short-serving directors will be associated with financial distress firms. A monitoring managerial behavior may require well knowledge of the firm. In some case, shortertenured directors may not have sufficient firm-specific knowledge needed to control managers. Another possibility is that shorter-tenured directors may not be any more probing than longer-serving directors.

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Limitation The results of this study are subject to two major limitations, some of which affect many exploratory studies. First, our data were gathered in only one country in the Middle East. Although this adds to the richness of the study, it also limits our ability to predict from it. Second, the surveys were completed by a convenience sample of family businesses that may not represent the larger population. Convenience samples are always suspected in generalizing to a population, but this sample is fairly large and comprehensive.

Conclusion Few studies have tackled the relationship between corporate governance characteristics and Lebanons corporate financial distress. Consequently, this paper represents a small step towards the exploration of this specific relation. It analyses, in fact, the contribution of some governance characteristics to the financial distress that the Lebanese economy has experienced. We were able besides to reach some results that are similar to prior papers related to the correlation between governance characteristics and financial distress predictions. Our main conclusion revolves around the fact that a high proportion of outside directors on the board are negatively associated to financial distress. Some studies that were also mentioned in our literature review are somehow in line with another result. It suggests that board independence improves firm performance. Furthermore, poor financial performance is not resolved when the firms increase the number of outside directors on board. In addition, board size is also associated to financial distress while other characteristics turned out to be insignificant. In spite of the importance of qualitative institutional and cultural factors, governance has only been analyzed through a quantitative point of view. In conclusion, we would highly appreciate new papers that analyze the influence of managerial power on board dynamics. It is noteworthy that these results are promising; nevertheless, they should be cautiously approached without transcending the context provided in this study. As the Middle East enters a new phase of growth and integrates more closely with the global economy, family businesses that ignore corporate governance now are likely to lose their competitive edge in the future. Tribal societies have long focused on the family as the unit of interest. Families predominate in both politics and society. This importance of family extends to businesses, where approximately 95% of all private sector companies in Lebanon. It has a long tradition of family dominance over both rulers and business. This tradition has been traced to feudal times, but is pervasive even today. The Lebanese governments efforts to implement financial reforms have been impeded by political uncertainties and lack of consensus. There has been little progress in reestablishing the equity culture lost during the civil war, or in reforming a number of weaknesses in the legal and institutional corporate governance structure, leaving Lebanon in the bottom tier of emerging markets.

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