Int. J. Business Governance and Ethics, Vol. 7, No.

1, 2012 1

Corporate governance and firms in financial distress:

evidence from a Middle Eastern country

Charbel Salloum* and Nehme Azoury

Faculty of Business,
Holy Spirit University of Kaslik,
Kaslik, Lebanon
Email: salloum@usek.edu.lb
Email: nazoury@usek.edu.lb
*Corresponding author

Abstract: The objective of this paper is to determine the managerial governance

characteristics related to financially distress companies. The failure of boards
to accomplish their monitoring duties seemed to be one of the main reasons
behind the actual financial distress and bankruptcy that swept companies across
the planet. Through the analysis of a sample of 178 Lebanese non-listed and
family owned firms, the results showed that the boards (that have a higher
proportion of outside directors) are less inclined to face financial distress than
the boards with a lower proportion. In addition, a different conclusion proves
that the board’s 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 to regulatory authorities in the framework of making policies on
corporate governance reformation.

Keywords: corporate governance; financial distress; performance; board of

directors; bankruptcy; Lebanon.

Reference to this paper should be made as follows: Salloum, C. and Azoury,

N. (2012) ‘Corporate governance and firms in financial distress: evidence
from a Middle Eastern country’, Int. J. Business Governance and Ethics,
Vol. 7, No. 1, pp.1–17.

Biographical notes: Charbel Salloum is an Associate Professor at USEK, and

holds a PhD from Paul Cezanne University. He is the Academic Secretary of
the Faculty of Business Administration at the Holy Spirit University of Kaslik
where he teaches financial markets and portfolio management courses. He has
been trained on the New York Stock Exchange (NYSE) trading floor and at the
Chicago Mercantile Exchange (CME). He has been a visiting Professor at Paris
II Pantheon Assas Univesity, IAE Lyon 3, the George Washington University
and Scientific Collaborator at HEC Liege. He has published many articles on
corporate governance and financial distress in refereed and ranked journals.

Nehme Azoury is an Associate Professor at USEK, and holds a PhD from Paris
XI University. He is the Dean of the Faculty of Business Administration at
the Holy Spirit University of Kaslik, Lebanon, where he teaches strategic
management and corporate governance courses. He is the Secretary General of
the Arab Society of Faculties of Business, Economic and Political Sciences’
and member of the scientific committee of Eduniversal. He has been a visiting

Copyright © 2012 Inderscience Enterprises Ltd.

2 C. Salloum and N. Azoury

Professor at Paris II Pantheon Assas Univesity, Euromed Management, La

Rochelle University, IAE Lyon 3, the George Washington University and
Scientific Collaborator at HEC Liege. He is Editor in Chief of the Arab
Economic & Business Journal and electronic journal La Revue Libanaise de
Gestion et d’Economie.

1 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. That’s why the
corporate governance reforms were established, in order to improve the corporate board’s
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 family’s 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 stage, these firms will
undoubtedly face 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 analyse 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 corporate’s performance and avoiding financial distress, will be
developed.
This paper is presented as follows: firstly, we present a literature review and relevant
hypotheses. Next, we established the adopted methodology approach. Finally, we discuss
our results and conclusions.

2 Background and hypothesis development

2.1 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 sub-Saharan
 Corporate governance and firms in financial distress 3

Africa. The subsequent increases in revenue have resulted in drastic changes and
significant industrialisation within these countries. Contact with Western countries and
corporations improved the standard of living in the Middle East through better education,
improved healthcare, 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, Lebanon’s per capita income was similar to that of
Southern Europe (Fahed-Sreih, 2006), and the country was a commercial centre for the
entire Middle East.
Recent events, however, have undermined Lebanon’s historically healthy economy.
A 20-year civil war seriously damaged Lebanon’s infrastructure and cut its GNP output
by almost half. After the war ended in 1991, Lebanon’s main growth sectors were
tourism and banking. After the 11 September 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 money-generating activity or a market-driven
pursuit, are a way to enhance a family’s 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 (Saidi, 2003).
This special way of managing a business in Arab countries relates to the socioeconomic
and cultural backgrounds of these families (Ali, 1993).

2.2 Corporate governance in Lebanon

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 family-owned 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 (Chahine and
Safieddine, 2008). Lebanon’s 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 realised. 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 board’s 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 utilised
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
4 C. Salloum and N. Azoury

obligated to share 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 (Saidi, 2004). Pyramid structures allow families
to gain control of a number of holding companies and subsidiaries through ownership of
a small equity percentage in each business. Under Lebanon’s 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 company’s 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
company’s 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 analyse the directors’ unethical behaviours and the power dynamics of
the board to explain the financial distress causes.
 Corporate governance and firms in financial distress 5

3 Literature review

According to Baldwin and Scott (1983, p.505), “when a firm’s 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. Boritz (1991) depicts a process
of a financial distress that begins with an incubation period characterised by a set of bad
economic conditions and poor management who commit costly mistakes. Wruck (1990)
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 organisational theory literature. In declining or crisis periods, organisations often
engage in a mechanistic shift, from which centralisation of authority is the most widely
recognised outcome (Daily and Dalton, 1994). These authors also argue that centralised
authority has particular applications to the relationship between governance structure and
bankruptcy.
The issue of centralisation 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 (1998) 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
CEO’s 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 non-executive 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 Whitaker (1999), 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 (Fama and Jensen, 1983). 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
6 C. Salloum and N. Azoury

due to an insider-dominated board. Based on this theoretical framework between

financial distress and board of directors’ composition and structure, it is hypothesised
that:
H1: A board with a smaller percentage of outside directors is positively related 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 analysing 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 Lebanese
society. Most of these types of Lebanese firms usually face kind negative operating
income due to expenses related to non-firms activities and based on inappropriate
extortion of firm’s 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 related with financial distress.
Jensen and Meckling (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 optimisation
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 very 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.
 Corporate governance and firms in financial distress 7

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 (2004) 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 Vera (2008) 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 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,
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 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. Lebanese’s board sizes are
usually larger than normal. Being a member of the board is usually associated to prestige
and recognition only without any effectiveness or added value because it’s 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 associated with financial distress.
8 C. Salloum and N. Azoury

Short tenure directors and longer tenure directors do not have the same firm knowledge.
Thus, they are unable to act in favour 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 maximise their wealth with
the help of firm performance. Consequently, the steward’s 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) analysed 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 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 Lebanese’s 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.

4 Research design

The Lebanese Republic provides a unique living laboratory in which to explore family
business development (Welsh and Raven, 2006). 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 analyse the
characteristics of family business’s 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 family owned 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 non-financial 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 (2004–2008). A questionnaire survey was
 Corporate governance and firms in financial distress 9

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 Sample selection

Financial Non-financial
Sector Initial number
distressed firms distressed firms
Agriculture 7 4 4
Chemical products 6 3 3
Construction materials manufacture 9 4 4
Cosmetics 5 2 2
Distribution 24 9 9
Electrical equipment & supplies 6 3 3
Financial services 25 13 13
Food industry 13 6 6
Hospitality industry 23 14 14
Jewellery 8 3 3
Media & telecommunications 8 4 4
Pharmaceutical industry 4 3 3
Private contracting industry 10 3 3
Publicity & advertisement 6 3 3
Publishing & printing industry 8 3 3
Services 20 8 8
Textile industry 6 2 2
Tourism & leisure 12 2 2
Total 200 89 89

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 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 are in Lebanon. It has a long tradition of family dominance over
both rulers and business (Welsh and Raven, 2006). 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.
10 C. Salloum and N. Azoury

Lebanon’s equity market is relatively underdeveloped compared to other countries

in the region. Total market capitalisation 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 unfavourable 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 favourable 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 limited our research to firms
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 what
information was 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 modelled as follows:
F (financial distress = 1) = 1 / (1 + e – y)
and y = Θ0 + b1 * VAR1 + b2 * VAR2 + b3 * VAR3 + … + b8 * VAR8
where VAR1-VAR7 is corporate governance characteristics (gender, length of director
tenure) and VAR8 is the firm size. For the impact of firm’s size, we included the firm’s
number of employees as a proxy for the firm size. The variables and descriptions are
defined as follows:
NOUT: number of total outside directors
CEOD: number of CEO duality
INSO: insiders have 0 equity ownership
DWO: directors are women
DTO: total number of directors
DI9: directors over 9 years of tenure
EPL: number of employees
DEB: market debt value in USD
POUTD: 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.
 Corporate governance and firms in financial distress 11

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 distressed
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 capitalisation for additional information only
as the firm’s 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
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.
Table 2 Descriptive statistics and correlations for the main variables

Variable Sample size Minimum Maximum Mean Std. dev.

NOUT 178 0 9 1.45 3.014
CEOD 178 0 2 1.28 1.339
INSO 178 0 3 .76 1.234
DWO 178 0 2 .04 .282
DTO 178 4 18 8.19 2.886
DI9 178 0 5 1.39 3.506
EPL 178 45 199 113.2 32.418
DEB 178 211,375,449 9,311,555,912 4,124,009 5,208,113

Table 3 Correlation matrix among corporate governance variables

NOUT CEOD INSO DWO DTO DI9 EPL

NOUT 1
CEOD –.711 1
INSO .906 .401 1
DWO 1.323 .067 –.061 1
DTO 2.510** 1.628** .024 –.038 1
DI9 1.312 0.21 –.12 .037 .0997 1
EPL .414 .062 .081 .022 .083 .019 1
Notes: The number in the table is t-value. **, *: Significant at .05 and .1 levels
respectively.
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.
12 C. Salloum and N. Azoury

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).
Table 4 Mean value of corporate governance variables: Financial Distress Firms (1) and
Non-Financial Distress Firms (0)

Corporate
FNF vs. NFDF Sample size Mean Std. dev. Std. error
governance
DI9 1 89 0.28 2.298 0.953
0 89 2.49 1.138 0.717
CEOD 1 89 1.91 1.027 0.072
0 89 0.65 0.409 0.222
DWO 1 89 0.03 1.225 0.713
0 89 0.06 1.123 0.418
DTO 1 89 9.24 2.054 0.339
0 89 7.13 1.114 0.226
NOUT 1 89 0.77 2.295 0.474
0 89 2.13 1.579 0.304
INSO 1 89 1.24 1.968 0.295
0 89 0.28 1.572 0.274
30223.16867
EPL 1 89 918 4092
576.754
20067.60443
0 89 1,486 4954
261.917
POUTD 1 89 0.02 0.178 0.106
0 89 0.14 0.827 0.211
Notes: This table summarises the mean values of each variable for both groups.
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.
Table 5 Independent samples T test for equality of means

Corporate governance Mean difference F-statistics Sig. T-statistics

CEOD 1.21 .039 .72 .352
DWO –.02 .391 .187 –.501
DI9 –2.07 1.784 .038** –2.038
DTO 2.22 1.712 .012** 2.328
INSO .77 .226 .307 1.038
EPL –4 11 2.135 .257 –1.361
POUTD –.15 11.124 .002*** –3.069
Notes: 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) non-financial distress firms (0).
F-statistics, Significance level, and T-statistics are provided. **, ***:
Significant at .05 and .01 levels respectively.
 Corporate governance and firms in financial distress 13

5 Analysis and results

The results of the logistic regression analysis and the interpretation of the hypotheses are
presented in this section. 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 = Θ0 + b1 * VAR1 + b2 * VAR2 + b3 * VAR3 + … + b8 * VAR8
where VAR1–VAR7 is corporate governance characteristics (gender, length of director
tenure) and VAR8 is the firm size. For the impact of firm’s size, we included the firm’s
number of employees as a proxy for the firm size.
Table 6 Regression results of the models based on different variables

Model 1 Model 2 Model 3 Model 3 Model 4 Model 5

INSO –.421 –.319
DI9 –.139 –.182 –.254 –.151
CEOD .610 .042 .054 .112 .158
DWO .207 .173 .042 .238
DTO 2.119** 2.408** 2.329** 2.164**
POUTD –2.151** –2.484** –2.199** –2.234**
EPL .0002 .0002 .0002 .0002
Log Likelihood 356.40 398.21 277.51 185.73 248.18 238.92
2
Model x 29.87** 26.73** 19.71** 18.55** 11.24** 19.06**
Note: **: Significant at .05 levels.
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. It’s a way of describing the relationship between one or
more independent variable and a binary response variable (financial distress). As for
Models’ 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 related with
financial distress.
The hypothesis is confirmed. Since the number of outside directors varies widely, we
standardise 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 related with financial distress.
14 C. Salloum and N. Azoury

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 self-interest 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.
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 linked 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 associated 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
behaviours 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.
 Corporate governance and firms in financial distress 15

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 behaviour may require well knowledge
of the firm. In some case, shorter tenured 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.

6 Limitation

The results of this study are subject to two major limitations, some of which affect many
exploratory studies. First, our data was 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
generalising to a population, but this sample is fairly large and comprehensive. Further
work could be done on a local aspect and on the regional aspect that could lead us to
compare corporate governance practices impact on financial distress.

7 Conclusion

Few studies have tackled the relationship between corporate governance characteristics
and Lebanon’s 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
analysed through a quantitative point of view. In conclusion, we would highly appreciate
new papers that analyse 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. It could be a start
and a source for further and specific study related to the same topic where Lebanese
investors, who excessively go for short-term returns, and of help to regulatory authorities
in the framework of making policies on corporate governance reformation. Rich policy
implications may also be derived from our research. For example, strengthening the
corporate governance mechanism would help to reduce the likelihood of financial
failures and improve uniform mechanisms of control. As the Middle East enters a new
phase of growth and integrates more closely with the global economy and new political
reform, family businesses that ignore corporate governance now are likely to lose their
16 C. Salloum and N. Azoury

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, which include 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 government’s efforts to implement financial reforms have been
impeded by political uncertainties and lack of consensus. There has been little progress in
re-establishing 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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