CHAPTER 2

REVIEW OF RELATED LITERATURE

This section presents the researcher’s selected views and

perspectives of authorities on the topics, related to the study. Findings on

similar topics provide comprehensive background to the current study.

Corporate Governance

The relationship between the company’s management and the board

is called corporate governance that provides the system of specific goals the

firm wants to attain. It is also the system of stewardship and control to direct

associations in satisfying their long term monetary moral lawful and social

commitments and goals toward their partners. It is an arrangement of heading,

criticism and control utilizing directions, execution norms and moral rules to

consider the board and senior administration be responsible for guaranteeing

moral conduct by accommodating long haul consumer loyalty with investor

esteem. Kapunan (2017) said that its motivation is to boost the association's

long-term achievement, making maintainable incentive for its investors,

partners, and the country. As stated by Alla Mostepaniuk (2017) corporate

governance specifies how investors judge, control and guide the

management’s action and how the responsibilities are distributed to the owners

and managers.

Corporate Governance is an intricate procedure that includes

hierarchical, legitimate, monetary, motivational, and social instruments, the

blend of which gives the exceptional working condition that permits to limit costs

by decreasing the hole amongst supervisors' and proprietors' interests. The

efficient corporate administration isn't constrained by chiefs' and proprietors'

objectives; it needs to incorporate the premiums of speculators, providers,

customers, specialists, delegates of a nearby network, and government

officers, as the monetary accomplishment of a company relies upon the

fulfillment the greater part of its chains. In the Philippines, the Code of

Corporate Governance was established to increase standards on corporate

governance of Philippine corporation. Organizations don't need to agree to the

code, yet they should state in their yearly corporate administration reports

whether they conform to the code arrangements, recognize any territories of

rebelliousness, and clarify the explanations behind resistance. The Securities

and Exchange Commission (2016) established 5 main areas of the code with

the proper distribution of 16 principles. The main areas are the board’s

governance responsibilities, disclosure and transparency, internal control and

risk management frameworks, cultivating a synergic relationship with

shareholders and stockholders, and the duties of stakeholders.

Board’s Governance Responsibilities

Board’s Governance Responsibilities is the first main area for the code

of corporate governance which has 7 principles. As stated by the Business

Roundtable (2012), for an organization to have an effective and efficient

corporate governance, directors, managers, and senior management should

have a concentrated and prudent perspective with respect to the maintenance

of the highest standard of responsibility and ethics. In spite of the fact that there

are various lawful and administrative necessities that must be met, good

governance is much more than a checklist rundown of board and administration

arrangements and obligations. Likewise, even the keenest and all around
drafted approaches and techniques are bound to fall flat if the board and

administration are not dedicated to upholding them practically. As stated by

Chams from ESADE School of Business (2017), a fruitful corporate governance

structure for any organization is a working framework for principled objective

setting, compelling basic leadership, and proper checking of consistence and

execution.

Establishing a Competent Board is the first principle under the

Board’s Governance Responsibilities. The company shall be led by a skillful,

working board to cultivate the long-term achievement of the organization, and

to manage its competitiveness and productivity in a way consistent with its

corporate targets and the long-term relationship with the investors and

creditors. The Board should be made of directors with an aggregate working

information, experience or ability that is applicable to the organization's

business or part. The Board shall dependably guarantee that it has a suitable

blend of ability and aptitude and that its individuals stay fit the bill for their

positions exclusively and collectively, to enable it to satisfy its parts and

obligations and react to the necessities of the organization. As stated by Tuffley

(2016), a managing & CEO of the B team, a capable board chief is unified with

learned and commanding "atmosphere champions" making associations that

are for the most part instructed and educated on the dangers and opportunities

exhibited by climate change to the company.

Establishing Clear Rules and Responsibilities of the Board is the

second principle under the Board’s Governance Responsibilities. The roles,

obligations and accountabilities of the Board as given under the law, the

organization's articles, and by-laws, should be clearly be made known to all

directors, chiefs, and shareholders. The Board individuals should follow up on

a completely educated premise, in compliance with common decency, with due

perseverance and mind, and to the greatest advantage of the organization and

all investors. The Board shall be in charge of guaranteeing and embracing a

compelling progression arranging program for chiefs, key officers and

administration to guarantee development. Understanding one’s roles and

responsibilities should be his or her first task when appointed. The top

managerial staff is delegated to follow up for the benefit of the investors to run

the everyday issues of the business. Leading with, Intent (2017) elaborated that

the board are straightforwardly responsible to the investors and every year the

organization will hold a yearly broad gathering at which the executives must

give an answer to investors on the execution of the organization, what its

feasible arrangements and systems are and furthermore submit themselves for

re-election to the board.

Establishing Board Committees is the third principle under the Board’s

Governance Responsibilities. The Board shall set up board committees that

focuses on particular board capacities to help in the ideal execution of its parts

and duties. Board committees’ groups shall be set to the degree conceivable to

help the execution of the Board's capacities, especially as for audit review, risk

management, related organization transaction, and other key corporate

administration concerns. The composition, capacities and obligations of all

advisory groups built or made shall be publicly available Committee Charter.

Board Committees, for example, the Audit Committee, Corporate Governance

Committee, Board Risk Oversight Committee and Related Party Transaction

Committee are important to help the Board in the viable execution of its
capacities. The kind of board committees to be built up by an organization

would depend on its size, risk profile and many-sided quality of activities.

Nevertheless, if the committees are not built up, the functions of these panels

might be completed by the entire board or by some other board of trustees.

Chen & Wu (2016) explained that board advisory groups are generally utilized

by expansive organizations to help the top managerial staff to manage, and

settle on choices on, unpredictable or specific issues. They play an important

role in a company’s corporate governance and enable directors to use their time

more efficiently and effectively.

Fostering Commitment is the fourth principle under the Board’s

Governance Responsibilities. To indicate full commitment to the organization,

the directors shall give the time and consideration necessary to effectively and

efficiently execute their obligations and duties, including adequate time to be

comfortable with the company's business. The directors shall go to and

effectively take an interest in all gatherings of the Board, Committees, and

Investors personally or through video or tele communication directed in

accordance with the rules and controls of the Commission, aside from when

reasonable causes, for example, sickness, passing in the close family and

genuine mishaps occur, in which counteract them from doing as such. In Board

and Committee group gatherings, the director should review meeting materials

and if called for, ask the vital inquiries, or look for clarifications. As stated by

Marcus Erb (2016) rewards and promotion can be implemented to ensure

employees commitment and making sure that everyone has an equal chance

to be recognized.
 Reinforcing Board Independence is the fifth standard under the Board's

Governance Responsibilities. The board should practice executing a goal and

autonomous judgment on every corporate issue. The Board shall have no less

than three autonomous executives or such number as to constitute no less than

33% of the individuals from the Board, whichever is higher. As stated by Busirin

Azme & Zacaria (2015), the importance of independent directors in the Board

is to guarantee the activity of free judgment on corporate issues and legitimate

oversight of administrative execution, including counteractive action of

irreconcilable situation and adjusting of contending requests of the partnership.

There is expanding worldwide acknowledgment that more independent

directors in the Board prompt more target basic leadership, especially in

irreconcilable circumstances

Assessing Board Performance is the sixth principle under Board’s

Governance Responsibilities. The best measure of the Board's viability is

through an evaluation procedure. The Board shall frequently do assessments

to evaluate its execution as a body, and survey whether it has the correct blend

of foundations and skills. The Board should direct a yearly self-appraisal of its

execution, including the execution of the Director, individuals, and boards of

trustees. At regular intervals, the evaluation shall be upheld by an outer

facilitator. Board appraisal causes the directors to completely audit their

execution and comprehend their parts and duties. The intermittent audit and

evaluation of the Board's execution as a body, the board panels, the individual

executives, and the Administrator indicate how the aforementioned shall

execute their duties adequately. Likewise, it gives a way to evaluate an

executive's participation at board and advisory group gatherings, investment in

meeting room exchanges and way of voting on material issues. Harvard

Business Review (2017) said that the utilization of an outer facilitator in the

appraisal procedure builds the objectivity of the same. The outer facilitator can

be any free outsider, for example, yet not restricted to, a counseling firm,

scholarly establishment or expert association. Board self-evaluation empowers

the board to hold itself, its individuals, and its procedures responsible, to

recognize holes between current execution and expected or sought-after

execution, and chart a course of improvement, refinement, and or further

progress.

Strengthening Board Ethics is the last and seventh principle for Board’s

Governance Responsibilities. Individuals from the Board are compelled by a

solemn obligation to apply high moral benchmarks, taking into account the

interests all shareholders. The Board shall adopt a Code of Business Direct and

Morals, which would give principles for proficient and moral conduct, and

additionally explain satisfactory and unsuitable direct and practices in interior

and outside dealings. The Code shall be legitimately dispersed to the Board,

senior administration, and representatives. It shall likewise be revealed and

made accessible to people in general through the organization site. AS stated

by US National Library (2015) a Code of Business Conducts and Ethics

formalizing moral qualities is an imperative apparatus to impart a moral

corporate culture that swarms all through the organization. The fundamental

duty to make and outline a Set of accepted rules appropriate to the necessities

of the organization and the way of life by which it works lies with the Board. To

guarantee appropriate consistence with the Code, proper introduction and

preparing of the Board, senior administration and workers on the same are
necessary. Strengthening an organization’s ethics plays a vital role to avoid

corporate scandals.

Disclosure and Transparency

Transparency and Disclosure are fundamental components of a powerful

corporate administrative structure, as they give the base to educated choice

making by investors, partners, and potential speculators in connection with

capital portion, corporate exchanges and monetary execution observing. The

two scholastics and market controllers have broadly perceived the significance

of transparency, bringing about various guidelines and directions being

presented after some time to guarantee convenient and reliable disclosure of

financial data, making models to which organizations must follow. Fung (2014),

states that Corporate administration in the present worldwide condition has

turned out to be more mind boggling and dynamic lately due to expanded

administrative prerequisites and more noteworthy examination, making

expanded obligations regarding top managerial staff to conform to thorough

administration measures and furthermore adapting with expanding interest for

T&D. There are four principles under in the disclosure and transparency as

stated in the code of corporate governance.

Establishing a Corporate Disclosure Policies and Procedures is the first

principle under disclosure policies and procedures. Organization of Economic,

Cooperation and Development (2015) stated that a solid disclosure

administration can help to pull in capital and keep up trust in the capital markets.

In differentiating, a weak disclosure and non-transparent practices can add to

unethical conduct and to loss market honesty at incredible cost, not simply to
the organization what's more, its investors yet in addition to the economy

overall.

Establishing a Standards is the second principle under disclosure policies

and procedures. As mention in Securities and Exchange Commission (2015),

An acceptable standard should be ought to build up in company for the fitting

selection of an external auditor and should practice a compelling oversight of

the same to fortify the external auditor’s independence and to excessively

improve the nature of the audit. It should be adhering with the accounting

standards.

Ensuring that the materials and non-reporting information are disclose

properly, and it is the third principle under the disclosure policies and procedure.

A disclosure helps the public to understand the practices, activities and

performance of the Company, with regards to ethical standards. It is proper to

fully disclose to the market all material associated to transactions with the

related parties and should indicate whether the transactions were executed in

a normal market term (PriceWaterhouseCoopers 2015).

Maintaining a comprehensive and cost-efficient communication is the last

principle under the disclosure and transparency. Disclosure of dependable,

timely data adds to fluid and effective markets by empowering financial

specialists to make speculation choices in view of most of the accessible data

that would be material to their choices. As a result, financial specialists are

requesting better announcing and more noteworthy transparencies (Fung

2014).
Internal Control System and Risk Management Framework

A proper risk administration and internal control enable associations to

comprehend the dangers they are presented to, set up controls to counter

threats, and adequately seek after their objectives. They are along these lines

a vital part of a governance, administration, and tasks (International Federation

of Accountant 2016). Internal Controls should be receptive to the particular

nature and necessities of the business. Consequently, they should try to reflect

business practice, stay applicable after some time in the evolving of business

environment and enable the organization to react to the needs of the industries

or business.

Securities and Exchange Commission (2016), Ensuring Integrity,

Transparency and Proper Governance is the only principle under the Internal

Control System and Risk Management Framework. It is to ensure that the

company should have a strong foundation and effective internal control system

and risk management framework.

Cultivating a Synergic Relationship with Shareholders

Securities and Exchange Commission 2016 principle 13 promoting

shareholder rights listed in the Code of Corporate Governance or the first

principle under Cultivating a Synergic Relationship with Shareholders states the

company should treat all shareholders fairly and equitably, and also recognize,

protect and facilitate the exercise of their rights.

There has been an exceptional spotlight on the part of shareholders in

the 2008 financial crisis and an acknowledgment that short-term theoretical

conduct assumed a key part in the worldwide financial market end. Shareholder

cultivation will become increasingly important for public corporations who thinks

about creating and accomplishing long term value. The aim of shareholder

cultivation is to distinguish, pull in, and develop a center of conferred

shareholders stewards who comprehend the company's purpose and values.

As a leading cover of the significance of stewardship contends the

accomplishment of companies and the societies in which their work relies upon

the exercise of stewardship. Public enterprises express this longing to develop

investor stewards from various perspectives. (Belifanti 2014)

Business Roundtable (2012) trusts that shareholder esteem is enhanced

when a corporation connects viably with its long-term shareholders.

Corporations ought to deliberately think about the perspectives of shareholders

but remember the obligation of the board to act in what it accepts to be the best

advantages of the corporation and every one of its shareholders. It is in a

corporation’s best enthusiasm to treat employees reasonably and equally.

Organization of Economic, Cooperation and Development (2015) states

that the corporate governance system ought to secure and facilitate the activity

of shareholders rights and guarantee the fair treatment of shareholders,

including minority and foreign shareholders. All shareholders ought to have the

chance to obtain effective review for infringement of their rights. Shareholders

rights to impact the corporations focus on certain central issues, for example,

the decision of board individuals, or different methods for affecting the structure

of the board, changes to the company's natural reports, approval of

extraordinary transactions, and other fundamental issues as indicated in

company law and interior company statutes. The capital that the shareholders
invested in the corporation will be protected from misuse. Shareholders ought

to have the chance to partake successfully and vote by in shareholders meeting

and should be educated of the rules, including voting procedures, that represent

general shareholder meeting.

Duties of Stakeholders

Securities and Exchange Commission (2016) principle 14 states the

rights of stakeholders established by law, by contractual relations and through

voluntary commitments must be respected. Where stakeholders’ rights and or

interests are at stake, stakeholders should have the opportunity to obtain

prompt effective redress for the violation of their rights. Principle 15 states a

mechanism for employee participation should be developed to create a

symbolic environment, realize the company’s goals and participate in its

corporate governance processes. Principle 16 states the company should be

socially responsible in all its dealings with the communities where it operates.

It should ensure that its interactions serve its environment and stakeholders in

a positive and progressive manner that is fully supportive of its comprehensive

and balanced development.

The corporate governance framework ought to perceive the privileges of

stakeholders built up by law or through mutual agreements and support

dynamic cooperation amongst corporations and stakeholders in creating

wealth, occupations, and the sustainability of financially sound undertakings. A

key part of corporate governance is concerned about guaranteeing the stream

of capital to corporations both in the value of equity and credit. The governance
structure ought to perceive the interests of stakeholders and their commitment

to the long-term success of the corporation.

Organization of Economic, Cooperation and Development (2015) states

that the privileges of stakeholders that are established by law or through mutual

agreements are to be respected. Where stakeholder interests are ensured by

law, stakeholders ought to have the chance to acquire effective redress for

infringement of their rights. Components for employee support ought to be

permitted to develop. Where stakeholders take part in the corporate

governance process, they ought to approach applicable, adequate, and reliable

data on a timely and regular basis. Stakeholders, including employees and their

agent bodies, ought to have the capacity to uninhibitedly convey their worries

about unlawful or exploitative practices to the board and to the capable public

authorities and their rights should not be imperiled for doing this. The corporate

governance framework ought to be supplemented by a successful, proficient

bankruptcy system and by viable authorization of creditor rights.

Financial Performance

An explicit and working corporate governance framework encourages

the firm to pull in investment, raise subsidizes, and reinforce the establishment

for firm performance. Investors will probably be pulled in to companies that

disclose ideal corporate governance issues since they see very much governed

firms to be less risky. Thus, firms with a sound corporate governance framework

will have an enhanced performance. Firms performance referred to as measure

of the productivity and adequacy of internal also external operations. In this day
and age, the execution of the performance of the firm is considered as the body

of the organization in light of the fact that if the execution of a firm is well enough

just than the firm’s growth would be enhanced. Firm’s performance can be seen

through the financial statements which are reported by the company.

There have been numerous studies for the subject of corporate

governance. Although the fact that these studies have concentrated on the

connection between corporate governance and firm performance, the

outcomes have not been convergent. Some of these studies revealed a positive

effect on corporate governance on financial performance. Varshney, Kaul and

Vasal (2012), who provide empirical confirmation that good corporate

governance practices positively affect a firm’s performance as measured by

economic value added. However, when other customary performance

measurements, such as, Tobin’s Q, return on capital utilized and return on

assets are considered, this relationship cannot be validated. Makki and Lodhi

(2014) examine the existence of a critical structural relationship between

corporate governance, intellectual capital proficiency and financial

performance. They find no significant relationship between corporate

governance and firm’s financial performance. However, good corporate

governance in a firm has a significant positive effect on intellectual capital

proficiency which by implication improves its financial performance.

Reliable findings of Wahba (2015) utilizing an example of 40 Egyptian

listed firms shows that expanding the extent of non-executive board members

under Chief Executive Officer duality adversely influences firm financial

performance. A study of public listed companies across Sub-Saharan African

countries have embraced good corporate governance practices, and its impact
on firm’s performance and market valuation, discovered companies complying

with good corporate governance practices accomplish higher financial

performance. However, their study found a negative relationship between the

corporate governance and market valuation. Azeez (2015) has analyzed the

relationship between corporate governance and firm performance among 100

listed firms in Sri Lanka on the Colombo Stock Exchange for 2010-2012

financial years found a negative relationship between board size and firm

performance. Isolating the part of the Chief Executive Officer (CEO) and

chairman has a critical association with firm performance and having more non-

executive directors has no relationship with firm performance among listed firms

in Sri Lanka.

Return on Asset

Return on Asset (ROA) is an indicator of how profitable a company is

with respect to its aggregate resources. ROA gives a manager, investor, or

expert a thought in the matter of how productive a company’s management is

at utilizing its assets to generate earnings. In essential terms, ROA reveals to

you what income were created from contributed capital. ROA for public

companies can change generously and will be profoundly subject to the

industry. This is the reason when utilizing ROA as a relative measure, it is best

to compare it against a company’s previous ROA numbers or against a

comparable organization’s ROA. ROA is most valuable for comparing

companies in a similar industry, as various industries utilize assets differently.

 Rostami, Rostami and Kohansal (2015) investigates the impact of

corporate governance on return on assets and stock return of companies listed

in Tehran stock trade. With a specific end goal to test the speculation, around

469 firm year observations were gathered utilizing methodical sampling for a

period of seven years. The outcomes indicate that there is a significant positive

relationship between ownership concentration, board independence, Chief

Executive Officer (CEO) duality and CEO tenure and return on assets. On the

other hand, there is a significant negative relationship between institutional

ownership and board size and return on assets. Besides there is a significant

positive relationship between institutional ownership, Board independence,

CEO duality and CEO tenure with stock return. However, there is a significant

negative relationship between ownership concentration and Board size with

stock return. Rostami, Rostami and Kohansal (2015) aimed to examine the

relationship between corporate governance mechanisms and value of the firm.

Their study is based on 93 listed nonfinancial companies in Dhaka Stock

Exchanges (DSE) 2006. The relationship between corporate governance and

the value of the firm contrasts in the diverse nations because of divergent

corporate governance structures resulting from disparate social, financial and

regulatory conditions in these nations.

The outcomes of the study of Rostami, Rostami and Kohansal (2015)

additionally delights a positive significant relationship amongst ROE and board

independent director and also Chief Executive Officer duality. The study, be

that as it may, could not give a significant relationship between the value of the

firm measures (ROA and ROE) and board size and board audit committee. The

return on asset gives investors a perception of how compelling the company is

in changing over the cash it invests into net income. The higher the ROA, the

better, in light of the fact that the organization is gaining more cash on less

investment.

Return on Equity

Return on Equity (ROE) is a financial ratio that figures the measure of net

profit earned as a level of investors' value or equity. It uncovers how

productively an organization has utilized investors' money. ROE is processed

as net profit separated by net worth (i.e. equity+ reserves+ retained earnings).

At the point when an organization has a low ROE, it implies that the organization

has not utilized the capital contributed by investors proficiently. It mirrors that

the organization isn't in a situation to give financial specialists considerable

returns. Stephen Karphin (2016) additionally stated that ROE is best used to

analyze organizations in a similar industry. Execution proportions like ROE,

focus on past execution to get a check on future desire.

Dia Rekhi (2016) stated that Investigators feel if an organization's ROE is

under 12-14 for each cent, it isn't palatable. Organizations with ROE of 20 for

each cent or more are viewed as great speculations. Experts alert financial

specialists not to consider organizations that have a negative ROE, particularly

in this unpredictable environment. Kent Chong (2018) identified that a high ROE

isn't only a sign of a productive organization. It likewise demonstrates that an

organization is great at utilizing its retained earnings proficiently. Retained

earnings is a source of capital for organizations. Organizations dependably

keep benefits to back its day by day tasks. It is an inward source of financing

which is free from Interest expense. Retained earnings have insignificant

dangers since it doesn't expand the obligation of the organization. A high ROE

can demonstrate if an organization is utilizing held profit to produce incomes. A

speculator could look at the organization's past financial report to examine it.

Theoretical Framework

This study acquaints a hypothetical structure suited with the setting of Sri

Lanka, based on agency, stewardship and stakeholder theories to address the

connections between corporate administration practices and firm execution in

Sri Lanka. In this system corporate governance factors (authority structure,

arrangement and panels) show up as checking components of the board,

though responsibility to investors and different partners is evaluated through

corporate detailing practices of CSR reporting through firm execution.

The four factors identified with corporate governance practices, which are

exceptionally huge in the Sri Lankan setting in influencing firm performance in

this study include: board authority structure, board creation, board advisory

groups and corporate reporting practices. The firm performance is estimated as

far as accounting and market-based measures.

Conceptual Framework

This study aims to determine the significant relationship between

corporate governance principles and performance of service sectors in the

Philippines. Figure 2.1 illustrated below shows the independent and dependent
variables of the study. The first variable which is the independent variable is the

main sections on Code of Governance. This variable aims to determine the

compliance of service sectors in the Philippines in terms of board’s governance

responsibilities, disclosure and transparency, internal control and risk

management framework, cultivation synergic relationship with shareholders

and duties of stakeholders. The second variable, the dependent one, is to

investigate the impact of corporate governance on financial performance of

service sectors in the Philippines in terms of return on assets and return on

equity.

COMPLIANCE
EFFECT ON FINANCIAL
 Board’s Governance PERFORMANCE
Responsibilities  Return on Assets
 Disclosure and  Return on Equity
Transparency
 Internal Control and
Risk Management
Framework
 Cultivating a synergic
relationship with
shareholders
 Duties of Stakeholders

Figure 2.1