Does Corporate Governance Spillover Firm

Does corporate governance spillover firm
performance? A study of valuation of

MENA companies
Mahmoud Arayssi and Mohammad Issam Jizi
Abstract Mahmoud Arayssi and

Purpose – The aim of the paper is to examine the association of corporate governance (CG), the Mohammad Issam Jizi are
firms’ characteristics and the financial performance of firms operating in the Middle East and North both based at the Adnan
Africa (MENA) region after Arab Spring. The study focuses on CG, exemplified by boards’ Kassar School of Business,
composition and ownership structure. It also explores the possible moderating effects of Lebanese American
environmental social and governance characteristics (ESG), leverage and size on the relationship
University, Byblos,
between CG and the company’s performance.
Lebanon.
Design/methodology/approach – Using Thomson-Reuters database, a sample of 67 firms was
extracted in the MENA region to measure CG and financial performance post Arab Spring from 2012 to
2016. Panel GLS regression random effects is used to quantify the relationship; robustness is checked by
using several alternative regressions and specifications to the performance measure.
Findings – The results reveal that board independence (BI) is negatively correlated with firm profitability
but ownership concentration and board gender diversification contribute to profits. When firms that
voluntarily form a governance committee are examined, ownership is less concentrated. We obtain a
stronger impact of good governance on performance in these firms: board composition, in general, and
workers’ satisfaction generate more profits; and undertaking ESG activities become a more dispensable
activity. The effect of board size (BS) and forming a governance committee are studied and ensuing
recommendations are drawn. In addition, relevant internal control of firms’ characteristics that strongly
predict firms’ market values are discussed in the context of agency and stewardship theories.
Originality/value – Despite the fact that governance-performance nexus has been extensively
discussed and examined, the focus of this volume of research is on western developed countries. The
growing economies of the MENA countries, and the limited governance-performance literature in the
MENA context have created a demand to understand the governance environment in these countries
and its influence on firm’s performance. In this region where firms’ owners are mainly family members,
governments and/or institutions, governance is typically weak; moreover, ownership concentration is
expected to guarantee good performance, as the role of independent directors becomes ineffective. For
firms where ownership is more diluted, a sound governance system should be established to replace
ownership concentration, and to more efficiently monitor management, and consequently improve firm
performance. Therefore, this study not only contributes a summary of the prevailing corporate structure in
MENA. Moreover, it explains the settings where both the stewardship and agency theories apply in
MENA firms. Some recommendation on the importance of changes to the existing governance rules are
highlighted in terms of more rules requiring board independence, board gender diversity, limits on board
size and establishing governance committees.
Keywords Corporate governance, Financial performance, Ownership structure, MENA countries,
Board composition
Paper type Research paper
1. Introduction JEL classification – G32, F65
Despite the significant increase in privatization, economic liberalization and diversification

Received 27 June 2018
since the Arab Spring, the Middle East and North Africa (MENA) corporate governance Accepted 1 August 2018
DOI 10.1108/SRJ-06-2018-0157 VOL. 15 NO. 5 2019, pp. 597-620, © Emerald Publishing Limited, ISSN 1747-1117 j SOCIAL RESPONSIBILITY JOURNAL j PAGE 597
system remains markedly different from the Western one. The ownership remains not as
diffused as in Western corporations, and boards are mainly composed of state or family
members; this makes the owners more likely to influence the monitoring quality and the
transparency level. In fact, Cobham and McNair (2012) argue that illegitimate flows from
developing countries (including MENA) in relation to handling of cross-border accounts and
financial secrecy have further impaired the transparency in these economies, to the benefit
of wealthier nations. Accordingly, conclusions of the available research, which is mainly
conducted on Western firms, may not specifically address the need of the MENA
regulators, policy makers and corporate managers. Our study aims at investigating the
association between firm financial performance and CG in the MENA setting, motivated by
the scarcity of studies on firms’ value, board characteristics and ownership structure in this
region. Good corporate governance (CG) ensures that the business environment is fair and
transparent and companies are held accountable for their actions (Larcker et al., 2007).
Hence, the interest in this aspect of business management is revealed by the extensive
literature on this topic. Whether or not these mechanisms play a role in the enhancement of
the financial activities and position of an enterprise, they have been of interest to several
researchers. Particularly, Shleifer and Vishny (1997) underlined the “enormous practical
importance” of CG (p. 737). Therefore, their comment emphasizes one of the appeals to
conducting research in this area: its direct association with company’s practice. CG
researchers have a unique outlook to directly inspire CG’s practices through the cautious
incorporation of theory and experiential study, especially on the inconsistency between
ownership and control and the deviation from the desirable one-share one-vote rule (La
Porta et al., 1998).
Agency theory, in an attempt to explain how companies co-exist with conflicts between self-
interested managers and shareholders, focuses on the key problem of separating
ownership and control, in terms of voting rights on important management decisions (Chen
et al., 2011; Harris and Helfat, 1998; Jensen and Meckling, 1976). Even in the USA and UK,
where ownership was long believed to be diffuse, large and dominant shareholders were
found to be not that uncommon (Holderness, 2009). Therefore, monitoring (i.e. board
oversight of executives) takes a central role in agency theory; also, it is fully consistent with
the view that the separation of ownership from control creates a situation conducive to
managerial opportunism (Jensen and Meckling, 1976).
Alternatively, under stewardship theory, the executive manager is described to be far from
being an opportunistic shirker, but someone who plans to do a good job and to be a good
steward of the corporate assets (Donaldson and Davis, 1991). Thus, stewardship theory
holds that there is no inherent problem of executive motivation. This theory implies that CEO
duality results in higher return to shareholders and that the positive effects of such duality
are not because of the fictitious effects of long-term compensation (Eddleston and
Kellermanns, 2007).
Though the association of CG and financial performance has been studied previously by
several scholars (Sanda et al., 2010; Gruszczynski, 2006; Larcker et al., 2007; Khanchel El
Mehdi, 2007), this study investigates this relationship in the MENA countries which, until
today, is characterized by overall weak CG. For this research, elements characterizing
board and ownership structure are used to study performance and control, for several firm-
important regional variables of publicly listed corporations operating in the MENA region,
and in light of recent political changes. Our results suggest that in the MENA setup, the
concentrated ownership of family members, governments and/or institutions, exercises tight
monitoring and control, partially substituting for the need of higher board independence.
This result supports the stewardship in favor of the agency theory. However, we find that for
firms where ownership is more diluted, the firm institutes a sound governance system,
evidenced by the formation of a governance committee; in this case, independent directors
PAGE 598 j SOCIAL RESPONSIBILITY JOURNAL j VOL. 15 NO. 5 2019

are more efficient in monitoring management, and consequently improving firm
performance.
The remainder of the article is organized as follows: Section 2 surveys the main features of
MENA firms. Section 3 reviews the pertinent literature. Section 4 presents the methodology.
Section 5 reports our empirical results. Section 6 concludes.
2. Main features of the Middle East and North Africa corporate system
We point out the main features of the MENA corporate system, to showcase the
background of the results in this study. The social structures in the Arab countries
highlight the importance of family, relatives and tribe networks as sources of social
sustenance and of business prospect. The united community of believers implies
taking advantage of economic opportunities and encouraging the attainment of
wealth through business transactions. Specifically, the economies of the Gulf
Cooperation Council region have experienced significant economic growth and
increased diversification throughout the last decade. For example, Saudi Arabia
Companies Law of 1965[1] states that the size of the board must be between three
and eleven, and one-third of the board of directors (BOD) should comprise non-
executives. In addition, newly emerged and dynamic industries include tourism,
leisure, construction, media, communication technology, consultancy and education
(Baydoun et al., 2012; Lassoued et al., 2016; Omet, 2005). The region experienced
privatization of many state-owned banks, which brought the decline of state
ownership and the emergence of foreign owners (Lassoued et al., 2016).
The major organizational institutions in the region have also undergone changes, as
the largely state enterprises have been affected by economic liberalization (Naceur
et al., 2007). Indeed, other changes have been directed to loosen the over-
dependence on oil, to emerge from a state subsidy culture to an enterprise culture,
and to create job opportunities for an increasingly well-educated labor force, through
new investment streams (Naceur et al., 2007). Consequently, there is a move toward
creating a business environment in which Gulf nationals will play an increasing part,
expatriate work-forces will be less dominant, and business enterprises will restructure
to face the challenges of globalization (Okpara, 2011; Gospel and Pendleton, 2005).
In appreciation of the role of stock markets in entrenching CG through the
implementation and enforcement of listing rules and compliance by listed companies,
many countries introduced capital market laws (Klapper and Love, 2004). In fact, the
Capital Market Authority was introduced in 2003 in Saudi Arabia to regulate and
supervise investments in the local Tadawul stock exchange which is the largest in the
region (Baydoun et al., 2012; Lassoued et al., 2016; Omet, 2005). Actually, the
supremacy of state-owned enterprises, the propagation of family-owned firms and the
plurality of small- and medium-sized enterprises distinguish the business environment
of the MENA from that of the Western world where CG has been initiated (Omet,
2005). When combined with investor protection laws, these characteristics are not
incompatible with the practice of good CG, but still beg international guidelines to be
written to reflect the realities of doing business in the MENA.
In line with the Eastern tradition, the MENA corporate system differs markedly from the
Western one. Many of the Western corporations may be characterized by a diffused
ownership, with a large number of listed firms and few companies related by pyramids
(Bozec and Bozec, 2007; Denis and McConnell, 2003; Huang et al., 2009). As matter of
fact, they have a liquid stock market that provides corporate control to discipline bad
management (Heracleous, 2001). In contrast, one of the most relevant features of
MENA corporate ownership is the excessive level of ownership concentration. In MENA,
ownership concentration is reflected by the large number of shares held by strategic
VOL. 15 NO. 5 2019 j SOCIAL RESPONSIBILITY JOURNAL j PAGE 599

investor shareholders (i.e. corporations, holding companies, individuals and
government agencies) which exceeded 40 per cent on average (Claessens et al.,
2002). Furthermore, the fraction of shares left to minor shareholders in many firms does
not exceed 50 per cent (Claessens et al., 2002). In this case, fewer agency problems
arise when firms are unified in ownership and in management (Randolph and Memili,
2017).
Most studies highlight the importance of CG in terms of its private and public themes.
The BOD of some of the largest companies in the MENA region is controlled by
owners of firms; they are mostly government officials joint with royal family members
(Omet, 2005). The BOD of Oman Oil Company, Kuwait Petroleum Corporation, Saudi
company (SABIC) and Saudi Aramco, for example, have majority of government
officials with royal family members without any presence of private sector on the
board (Omet, 2005).
It is noticeable that the BOD is made of state or family members. Hence, the lack of
independent directors decreases the level of transparency and control executed on the
firms, which results in high level of corruption and fraud (Omet, 2005). To enhance the level
of CG, transparency and credibility, all companies must increase the number of
independent directors (Dalton et al., 1999; Denis and McConnell, 2003; Desoky and Mousa,
2012). Countries in the MENA region have undergone numerous reforms and restructuring
on legislative and infrastructure fronts (Piesse et al., 2012). However, the market’s discipline
is both a result and a supplement to massive reforms towards better governance, which is
only observed in matured efficient markets (Klapper and Love, 2004). Thus, adopting self-
regulatory organizations’ model remains a future challenge to the MENA region markets
(Omet, 2005). Market’s discipline has still not developed to an extent that effectively
improves CG practices.
Fundamentally, traditions and cultures should be allowed implicitly to choose their
acquaintance with one of the two systems and not vice versa. Using the opposite direction
might result in institutional failure, market crises and collapse of the investors’ wealth
(Klapper and Love, 2004). Singh and Singh (2010) claim that previous emerging market
crises were good evidence that economies in the MENA region are highly centralized in
government control or royal families. To prosper and develop, all MENA region countries
must take the incentive to increase the role of the private sector as a way of reform (Naceur
et al., 2007). Business in the Arab world is crony capitalism because the private sector must
be used to create millions of job opportunities and enhance the region’s economy. Hence,
Singh and Singh (2010) recommend that countries should adopt economic openness to
eliminate entry barriers, replace privileges with competition and ensure a decentralized and
rule based framework for decision making. Yet, the MENA region suffers from high levels of
fragmentation, which is mainly caused by a manifestation of internally segmented
administrative structures. The region’s centralized and segmented administrative
structures, and even sometimes failed government institutions in the aftermath of the Arab
Spring (Arayssi and Fakih, 2017), have restricted economic access, decreased
performance and prevented the distribution of economic rent. Consequently, this resulted in
a high level of coordination failures, which affected the ability of Arab governments in
capturing productive spillovers. Therefore, the dominance of family ownership has limited
the role of the private sector and CG; it has also prohibited entrepreneurship and
innovation.
Other findings suggest that MENA’s firms operate with leverage ratios not much different
from those observed in countries in other parts of the world (Ghazouani, 2005). Moreover,
evidence from MENA points out that firms set target capital structures and attempt to
converge to these targets partially, over time. Nonetheless, that convergence’s speed
varies from one country to another, possibly reflecting differences in institutional

environments across MENA countries. Ghazouani (2005) states that firms operating in
countries with relatively more developed financial systems, stronger rule of law and more
regulatory effectiveness tend to use greater financial leverage. However, more corruption
that characterizes most MENA countries can also lead to greater leverage, possibly,
because it can help in overcoming hurdles such as deficient collateral and overlooking
bankruptcy risks, hence easing access to loans.
3. Literature review
CG has become one of the most significant topics of corporate research. The failure of
Enron, among others, has led to a huge call for improved CG (Lavelle, 2002). As a
result of liberalization, the focus on CG has spread into the developing world. Many
developing nations, unlike the developed countries, lack a well-organized and
recognized framework for proficient CG. Research considers that CG in developing
nations has been comparatively variable and weak (Denis and McConnell, 2003;
Klapper and Love, 2004). Braendle et al. (2013) assert that CG is explicitly important in
the MENA but these economies show an absence of the conservatively recognized
infrastructure that deals with CG issues. Efficient CG is important, nonetheless, for firms
in developing countries, as it can lead to managerial vibrancy and quality as well as
help with raising capital (Okpara, 2011). Heracleous (2001) believes that good CG
means higher returns for the shareholders.
Moreover, Kiel and Nicholson (2003) aver that a mutual purpose of several theories of CG is
to establish an association between the diverse features of BODs and firm performance.
The board efficacy may differ according to the board size (BS), board independence (BI),
or even CEO duality. The agency theory backs up the notion that boards ought to be
dominated by directors outside the firm to augment the independence of the board from the
management (Heracleous, 2001). Researchers have been pointing out the importance of BI
for improving the value of the firm (Rosenstein and Wyatt, 1990; Agrawal and Knoeber,
1996). Adding to that, Arayssi et al. (2016) recommend increasing gender diversity in the
board because the presence of women on board improves the quality of ESG disclosures
and thus increases the firm’s value. However, Harris and Helfat (1998) remind that the
board members and executives must be characterized by unique skills and keep on
developing them because these specific skills will be always matched with the potential
desires of the corporation.
When it comes to BS, some researchers (Dalton et al., 1999) believe that a larger BS will
include beneficial diversity because different intellect will be brought to the board; and,
this will enhance the quality of the board decisions made. On the other hand, Hermalin
and Weisbach (2001) believe that smaller BS is better to avoid conflicts in coordination.
Allegrini and Greco (2013) claim that larger BS is significantly increases corporate
voluntary disclosure. According to Khlif and Souissi (2010), disclosure of information is
necessary for CG because it shows the power that a manager has in decision making
as well as how this power is allocated among the shareholders and the manager.
Nevertheless, the results of Tobin’s Q model were significant with ownership of largest
three shareholders dimension and size of BOD and insignificant with other dimensions
(Buallay et al., 2017).
Moreover, the main matters of ownership are the distribution of the equity and the
shares held by various members such as the BOD, top management and the CEO
(Dwivedi and Jain, 2005). When the ownership structure is highly diffused, there is no
enticement for any owner to closely monitor the management. This situation is unlikely
to happen, as this person would bear all the costs of monitoring while the remaining
shareholders would enjoy the benefits. Hence, having strategic shareholders may
avoid agency problems (Gillan and Starks, 2003). Morck et al. (1988) find that having

major investors of 5-25 per cent ownership causes negative effects for US firms. As
such, ownership concentration can be an internal governance mechanism that helps
reduce managerial opportunism, because managers and BOD are more likely to take
into accounts the preferences and interests of large shareholders (i.e. Bozec and
Bozec, 2007).
Ghazouani (2005) concludes that companies operating in countries with well-
structured and advanced financial systems, powerful legal systems and efficacious
regulation, achieve high financial leverage. Therefore, this shows that the level of
leverage depends on the level of trust and stability provided in the countries of
operation. Particularly, having strong connexions with bank administrators,
regardless of the financial viability of loans, will raise the leverage’s average,
especially during corruption periods in developing countries (Al-Ghamdi and Rhodes,
2015). Next to the leverage variable, firm’s size has its significant effects on the
profitability level of the firm (Buallay et al., 2017). For example, a holding company
surely has larger finance than any smaller firms, because it has access to more
financing sources, either by taking loans from banks or selling shares to stockholders.
ESG disclosures became a crucial aspect considering the future of all businesses (Allegrini
and Greco, 2013). Klapper and Love (2004) and Jizi (2017) recommend continuous
development of ESG disclosures in terms of quality and frequency, because this will boost
the firms’ level of transparency and accountability toward their stakeholders and
communities. In addition, the workforce score was found to affected by a motivating
environment in the workplace for the employees to increase productivity, profitability and
reliance in managers (Yoon and Suh, 2003).
The relationship between CG and performance may not be direct as some variables may be
moderating the association. When corruption is allowed for, the concentration moves to
corrupt officials who accept bribery. However, Wu (2005) argues that CG is a vital feature
which determines the corruption level. In addition, corruption results in greater inequality
and thus generates lower levels of trust (Rothstein and Uslaner, 2005).
The aim of this paper is therefore to investigate the associations between financial
performance and CG using the MENA annual data over the period of 2012-2016 through a
microeconomic model. The firm level data is extracted from Thomson Reuters (Eikon)
database. The relationship between profitability and CG and independence is analyzed. For
instance, when it comes to measuring a firm’s performance, Schuler and Cording (2006)
avow that financial performance is looked at in terms of a corporation’s profitability, market
value and growth. Islam et al. (2012) argue that the measures of financial performance
consist of investor’s and accounting returns. We use a similar model to the study conducted
on Saudi Arabian market (Buallay et al., 2017). They find no significant impact for CG’s
adoption on firms’ operational and financial performance in the listed companies in Saudi
stock exchange. They use the return on asset (ROA) and return on equity (ROE) in their
model. In fact, the findings of this study add interesting conclusions to the existing studies
on the MENA firms. They emphasize the role that developing economies should accord to
governance, through agency or stewardship theories, in order to help firms to run profitable
operations.
4. Methodology
4.1 Data
We use Thomson Reuter’s database as a source of panel data in our empirical model. We
combine these variables over the period between 2012 and 2016, which covers the post
Arab Spring era – one characterized by profound political and institutional alterations in the
MENA countries (Arayssi and Fakih, 2017). Our sample includes 67 public firms selected

from 13 Arab countries out of 23 countries in the MENA region. It includes Bahrain, Egypt,
Iraq, Jordan, Kuwait, Lebanon, Morocco, Oman, Palestinian Territories, Qatar, Saudi
Arabia, Tunisia and UAE. Some of the countries were not represented in the sample simply
because they did not fit the data selection criteria, in the sense that such firms did not report
some or any of the board, ownership or ESG characteristics that we are studying.
Henceforth, the incomplete data for many listed firms imposes some restrictions on the data
availability in the MENA region. Therefore, the sample that we have obtained reflects Arab
Spring survivorship bias; the designated firms have better CG on average than private firms
or other listed companies that failed our Thomson Reuters’ selection criteria on the stock
exchanges in MENA.
4.1.1 Dependent variable(s). The dependent variable is defined as the ROA, as computed
in the Thomson Reuters database (Danoshana and Ravivathani, 2013). It is taken as an
alternative measure for firm profitability. Alternatively, we use the rate of ROE and weighted
average cost of equity (WACE) as dependent variables in different model specifications (El
Ghoul et al., 2011).
4.1.2 Independent variables. Table I presents the definition of the variables used in the
empirical analysis.
4.1.2.1 BC indicators. We use four variables for board composition. First, we use the BI.
This variable is commonly used in the empirical studies on the CG’s effect on firm’s
profitability (Rosenstein and Wyatt, 1990; Agrawal and Knoeber, 1996). These studies
follow the agency theory in arguing that BI indicates a higher level of firm value.
However, stewardship theory believe that BI may not be profitable (Koerniadi and
Table I Variables definition

Variable Definition Measurement
Dependent variables
ROA Return on assets Net income divided by total assets
ROE Return on equity Net income divided by total shareholders’ equity
WACC cost of Weighted average cost It is calculated by multiplying equity risk premium of the market with the beta of
equity of capital the stock plus an inflation adjusted risk free rate. Equity risk premium is expected
market return minus inflation adjusted risk free rate
Independent variables
BI Board Independence The number of independent directors on the board to the total number of
directors
BGD Board Gender Diversity Percentage of females on the board
BS Board Size The total number of board members at the end of the fiscal year
BSS Board Specific Skill Percentage of board members who have either an industry specific background
or a strong financial background
OWN Owner Concentration Treasury Shares (if applicable) þ (Shares held by Strategic Entities/
Corporations þ Shares held by Strategic Entities/Holding Companies þ Shares
held by Strategic Entities/Individuals þ Shares held by Strategic Entities/
Government Agencies) as a per cent of total shares outstanding
Gov Com Corporate Governance Does the company have a corporate governance board committee?
Board committee
ESG Score Environmental Social Thomson Reuters ESG Score is an overall company score based on the self-
and Governance reported information in the ESG pillars
Criteria
Workforce Workforce Score Workforce category score measures a company’s effectiveness toward job
Score satisfaction, healthy and safe workplace, maintaining diversity and equal
opportunities, and development opportunities for its workforce
LogAssets Log Assets Log of Total Assets. Total assets (tangible or intangible) capable of being owned
or controlled to produce value and held to have positive economic value
Leverage Leverage This is the ratio of Total Debt to Total Assets as of the end of the fiscal period

Tourani-Rad, 2012). For robustness, we use three additional measures for BC. First,
board gender diversity (BGD) was shown by Arayssi et al. (2016) to increase firm
value. Second, BS is inversely related to firm profitability (Dwivedi and Jain, 2005;
Yermack, 1996). Harris and Helfat (1998) demonstrate that board specific skills (BSS),
which may be associated with BS, can be a negative contributor, as well, to firm
profitability.
4.1.2.2 Ownership and control indicators. The only variable used in this category
is ownership concentration, as measured by shares held by strategic investors in
per cent of total shares outstanding. Claessens et al. (2002) and La Porta et al. (1998)
find that the firm’s value increases with the cash-flow ownership of the biggest
stockholder.
4.1.2.3 ESG control variable. We use three variables for ESG. First, the governance
committee is illustrated in Huang et al. (2009) to result in less earnings overstatement,
possibly leading to a reduced rate of return. Second, the ESG score was proven by Klapper
and Love (2004) to increase firm value. Third, the workforce score was revealed by Yoon
and Suh (2003) to provide more incentive for workers to improve their level of customer
care, trust in manager and firm engagement.
4.1.2.4 Size control variable. This variable is measured by the logarithm of total assets
of the firm. Buallay et al. (2017) find a significant relationship between size and firm
profitability.
4.1.2.5 Leverage control variable. This variable is measured by the total debt to total
assets, at the end of the fiscal period, as a ratio. In classical models of capital structure,
firms would borrow as much as they could to take advantage of the tax shield that is offered
by the government. In this study which applies to countries with predominantly Muslim
regulations (i.e. Kingdom of Saudi Arabia), there is no effective tax shield for debt since
companies pay only zakat tax, a fixed, small 2.5 per cent of net profit (Al-Ghamdi and
Rhodes, 2015).
4.2 Empirical methodology

The primary objective of this paper is to examine the financial repercussions of CG in the
Arab countries since 2012, using the natural post-Arab Spring experiment. The structure of
the panel data allows us to follow firm i(i = 1,. . .,I) across time, t(t = 1,. . .,T):
ROAit ¼ ai þ b 1 BCit þ b 2 OWNit þ b 3 ESGit þ b 4 SIZEit þ b 5 LEVit þ « it (1)
where (« it) is the stochastic error term and (ai) the intercept which represents the firm
specific irregular return on assets (ROA), BCit is a vector of variables depicting the board
composition firm characteristics of the return of firm i in year t. OWNit is a vector of variables
representing the ownership and control structure component of the return. ESGit is the
vector of environment, social and governance component for firm i in year t of the return on
assets; SIZEit, and LEVit denote the size factor, and leverage (debt-to-assets) factors,
respectively.
As a robustness check, we use an alternate model with WACE as a dependent variable:
WACEit ¼ ai þ b 1 BCit þ b 2 OWNit þ b 3 ESGit þ b 4 SIZEit þ b 5 LEVit þ « it (2)
WACEit is the weighted cost of equity capital in firm i at time period t; the independent
variables are the same ones used in (1) above. In this specification and because we use
one element of the company cost, duality in the firm leads us to expect that the relationships
between the dependent and independent variables would be reversed from those in the
basic model (El Ghoul et al., 2011).

The majority of the US literature hints that CG enhances firm value by reducing WACE,
not just by improving the expected cash flows that can be distributed to shareholders.
Moreover, Chen et al. (2011) find that the marginal effect of CG on the cost of equity
appears stronger for firms with more severe agency problems. Therefore, under the
agency theory assumptions we expect BC to have a negative effect on WACE.
Similarly, OWN is anticipated to increase WACE, as concentration adds to the risk of
expropriation of small investors, whereas ESG should decrease the WACE.
The benchmark specification in equation (1) above can be estimated by using either
the fixed effects or the random effects model to handle the country effects that are not
captured by the explanatory variables. In the fixed effects model, the country effects
such as legal enforcement of rights and internal conflicts history, earnings
management levels, quality of stock market administration, etc. are (nuisances)
presumably captured by including “country dummies” to account for that unexplained
disparity. Under such a model, no assumptions are made about the above-mentioned
country effects. The scores on the dependent variable (return on assets) are
compared among the levels of the factor (country dummies) using differences
between means.
Conversely, in the random effects model, the country factors are assumed to follow a
constant mean and variance probability distribution. Thus, in the random effects
model, the variance of unexplained factors is estimated, whereas in the fixed effects
model, it is assumed that these factors have the same variance with an infinite value.
In this paper, we suspect that the correlation between unexplained factors and the
independent variables is very weak, as countries all belong to the same MENA region
and share many cultural and business values. For example, the variable BI should not
be correlated with these factors when the dependent variable is the rate of return on
assets (Lassoued et al., 2016). This inspires us to use the random effects model. In
addition, to check the appropriate empirical model, we depend on the Hausman test.
As usual, under the null hypothesis for the Hausman test the random effects model is
consistent. Therefore, because the p-value is insignificant then we know that the
random effects model presents a better fit for our data.
Empirical research reflects that governance has featured conspicuously in the economic
background recently. Black et al. (2006) argue that CG indicators predict company market
value well in emerging markets. Wu (2005) tests hypotheses that explicitly connect different
measures of CG to the level of corruption and find a direct impact of CG standards on the
effectiveness of any fight against corruption. This leads us to the following predictions
(stated in direct form).
4.3 Hypotheses
The vantage point of agency theory, which focuses on the monitoring of managers whose
interests are assumed to deviate from those of other shareholders, yields the following
hypothesis regarding board characteristics governance:
AH1. There are positive effects of board independence on firm performance in MENA
countries.
The first hypothesis that we are testing is the importance of the level of board composition
on firms’ profitability, and checks whether BI contributes positively to ROA. We generally
consider four aspects of board characteristics, specifically, BI, BGD, BS and BSS. In
general, we expect that the BI would reduce governance malpractices and increase the
bottom line of the firm, as other board members are more closely monitored by the
independent members of the board. It is also expected that more gender diversity
contributes positively to the firm’s value because it leads to more effective board functioning
through promoting firm’s good citizenship.

By contrast, stewardship theory yields the opposite hypothesis regarding board
characteristics governance:
SH1. There are negative effects of board independence on firm performance in MENA
countries.
However, the assumptions of agency theory may not fully relate to family-owned firms,
where the alignment of ownership and control is tighter, thus avoiding the necessity for
outside directors. More importantly, outside directors with little knowledge of the firm and
having less at financial stake, may reduce the company’s efficiency by diverting managers
and by affecting them to emphasize short-term objectives. In this instance, family-owned
firms may be better approached from the vantage point of stewardship theory. Klein et al.
(2005) found that for family-owned firms, BI’s effect is negative on profitability. Their finding
supports the assertion of several family-owned companies that a more independent board
does not automatically result in improved performance and that BI may not be damaging to
smaller shareholders. Reduced BS is likely to help firms reveal more information to the
public and make each of the board members more responsible and dedicated, thus
increase the firm’s profitability.
The BSS Thomson Reuters’ measure refers to the industry-specific or the strong
financial backgrounds; these fall under the human capital functional area. Although
boards must have members who enjoy such skills in these areas to make informed
acquisition or diversification decisions (Nonaka, 1994), it is not always certain that
they integrate their knowledge with synergies and creativity resulting from the firm’s
management. For instance, if the board members do not stimulate and respect
everyone’s skills, the board may not be able to use its knowledge to create synergies
to the firm. Harris and Helfat (1998) claimed that investor worries about the absence
of a selected successor with the required human capital to run a firm might result in
negative abnormal stock market returns. Therefore using that theory, one would
suspect that boards, without such lucid and prudent plans, may result in less trust
among each other and reduce the firm’s profitability; hence, BSS may turn to be a
negative contributor to firm profitability.
Agency theory produces the following hypothesis regarding ownership control governance:
AH2. There are negative effects of ownership control indicators on firm value
The second hypothesis touches on the relation between the ownership and control
(ownership concentration per cent of total outstanding shares) and checks whether
OWN contributes negatively to ROA. Normally, when concentration of control is high
in firms, the value of their shares tend to fall (Carvalhal da Silva and Pereira Camara
Leal, 2005; Joh, 2003) because of the potential of expropriation of the minority
stockholders. Hence, according to the agency theory we expect OWN to have a
negative influence on ROA.
The stewardship theory produces the reverse hypothesis concerning ownership control
governance:
SH2. There are positive effects of ownership control indicators on firm value.
Next, we test the effect of environment, social and governance indicators governance:
H3. There are ambiguous effects of environment, social and governance indicators on
firm value.
The third hypothesis deals with environment, social and governance dimension of a
firm and checks whether ESG contributes positively to ROA. We examine three
aspects of ESG in this paper, namely, ESG score, Workforce score and Governance
committee (see Table II below for variable definition). An expansion of ESG usually
results in a higher self-reported (ESG) score in the environmental, social and CG

Table II Summary statistics for both the full sample and the subgroup of firms that have a corporate governance committee
Variable Mean Maximum Minimum SD Skewness Kurtosis
ROA 4.28 (2.68) 39.91 (8.10) 29.86 (0.03) 6.26 (1.93) 1.29 (1.40) 13.14 (4.16)
ROE 14.01 (12.86) 135.6 (31.7) 40.33 (0.21) 12.76 (7.01) 2.89 (0.49) 32.27 (3.09)
WACE 10.80 (10.47) 20.36 (18.88) 3.98 (3.99) 3.36 (3.81) 0.11 (0.29) 4.01 (2.60)
BI 27.08 (22.98) 100 (72.73) 0.00 (0.0) 26.17 (22.77) 0.48 (0.47) 2.13 (1.83)
BGD 3.36 (4.70) 50 (20) 0.00 (0.0 7.41 (6.41) 3.38 (0.85) 18.21 (2.29)
BSS 31.29 (27.53) 88.88 (80.45) 0.00 (0.0) 22.23 (26.07) 0.49 (0.34) 2.56 (1.83)
BS 9.51 (9.85) 16.00 (14.0) 2.00 (7.0) 2.48 (1.77) 0.09 (0.50) 3.39 (2.35)
OWN 41.00 (30.93) 97.13 (80.45) 0.00 (0.0) 27.20 (26.07) 0.07 (0.34) 1.83 (1.83)
ESG Score 38.45 (47.59) 75.71 (75.71) 12.63 (20.84) 15.41 (16.74) 0.50 (0.12) 2.38 (1.66)
Workforce Score 32.03 (38.28) 93.91 (84.14) 0.99 (3.85) 22.94 (23.88) 0.45 (0.12) 2.08 (1.72)
Log Assets 10.06 (10.38) 11.30 (11.30) 8.72 (9.58) 0.58 (0.42) 0.15 (0.43) 2.27 (2.16)
Leverage 17.37 (11.22) 77.49 (37.86) 0.00 (0.0) 18.24 13.22 1.21 (0.86) 3.83 (2.20)
Note: Descriptive statistics of firms having governance committee are in brackets
VOL. 15 NO. 5 2019

j SOCIAL RESPONSIBILITY JOURNAL j PAGE 607
pillars, is efficient because it reduces firm’s risk and improves firm’s return (Arayssi
et al., 2016). Only in 2003 did the Securities and Exchange Commission (SEC, 2003)
make it mandatory for firms listed on the New York Stock Exchange to have a
governance committee, and that it should be formed completely by independent
directors. The existence of a governance committee was found to constrain
managerial opportunism and increases profitability by increasing conservative
financial reporting and accounting discretion (Huang et al., 2009). Therefore, the ESG
score is likely to increase ROA. Workforce score measures a company’s effectiveness
toward job satisfaction, healthy and safe workplace, maintaining diversity and equal
opportunities and development opportunities for its workforce. Effective governance
implies that organizations identify the impact of stakeholders on firm success and the
responsibilities that they have to the stakeholders, both internal and external, which
they serve. Firms need to respect and recognize the contribution of both, as they
depend on and provide sustenance to both groups, otherwise they would fail in
governance. Jacoby et al. (2005) determine from their analysis of Japan and the USA,
different governance systems that power challenges are important, particularly the
distribution of power between different stakeholders such as shareholders, clients
and employees. Moreover, Gospel and Pendleton (2005) argue that managers apply
strategic choice in their labor tactic and that they are not passive victims of finance
and ownership systems, and can “determine their labor strategies and seek to win
investor support for them” (80). One would thus expect the workforce score to
improve the profitability of the firm, if employees exercise their natural role in the
company governance.
Lastly, the following are control variables hypotheses:
H4. There are ambiguous effects of the size control indicators on firm value.
Firm size, measured as the log of total assets, is incorporated to account for the
potential economies of scale and scope accumulating to larger firms. When such
economies are present, they would yield a positive effect on profitability. However,
Klein et al. (2005) show that firm size is negatively related to performance in Canadian
firms. In addition, smaller firms have more scope for larger family ownership because
it would be easier for a family to back it up financially. Hence, size of firm exerts
ambiguous consequences on firm value:
H5. There are ambiguous effects of the leverage control indicators on firm value.
Leverage allows firms to access financial markets and increase profits, especially
because interest expense is normally tax deductible. Stiglitz (1985) discusses the
positive effect on firm performance as an outcome of monitoring performed by
lenders. Perrini and Minoja (2008) show that leverage was related negatively to firm
valuation, as bond holders do not benefit from the upside risk of a good performance
and shareholders prefer more leverage because it is cheaper and keeps them more in
control of the company. Therefore, capital structure yields ambiguous effects on firm
profitability.
This paper will test these seven hypotheses to provide an assessment of the empirical
validity of these two challenging theories.
4.4 Descriptive statistics

Table II provides descriptive summary statistics of the variables used in the analysis.
Financial variables show that 4.3 per cent is the average rate of ROA and 14 per cent
is ROE, whereas 10.8 per cent is the weighted average cost of equity (WACE). Thus,
the variations in these rates are considerably high and show an asymmetric

distribution of the rates of returns; however, WACE’s distribution is closer to a normal
distribution. Interestingly, board characteristics variables show a low ranking of the
Arab countries with BI being 27 per cent on average, BGD around 3 per cent of the
board members and BS tending to 9.5, which is on the high side; Jensen (1993),
recommends an optimal BS of 7-8 directors. The ownership variables show a mean
owner concentration around 41 per cent of total shares outstanding, with a very large
standard deviation. The largest declared shareholder holds 97.12 per cent of the
shares, indicates that some firms are mostly controlled by families or strategic
entities, including governments; this clearly argues in favor of strategic or family
investors controlling shares in firms. For most firms in our sample the shareholding of
the strategic investors is highly above 41 per cent, as evidenced by the positive
skewness of this distribution. In MENA, listed firms are hardly qualified as being
widely held, as companies rarely have owners with less than 10 per cent of control
rights (Claessens et al., 2002). Therefore, the high ownership concentration of firms,
using the aforementioned stewardship theory, may be useful in helping the internal
governance through providing incentives for management. These levels of ownership
concentration have been formed either through direct owners or through groups of
shareholders (La Porta et al., 1998). These stakes are bound together through a
voting alliance, possibly through family ties, as a response to the relatively weak
investor protection (La Porta et al., 1998).
The foregoing narrative may support the idea that a large number of listed firms in the Arab
countries are dominated by family firms. Hence, the separation between voting and
ownership may be weak in MENA. In our context, it would not be inconceivable for a family
owner to possess considerable power in the management of the firm. Voting data being
scarce in this region, we were not fortunate to collect any useful information regarding this
important shareholders’ variable. However, large owners may vote in blocks, that would
give majority votes to strategic investors. This leads us to believe that the separation
between ownership and control, though probably skewed to the major shareholders’
interest, is mildly taking place.
The ESG variables show low CG scores as well, averaging about 38 per cent and 32
per cent for the ESG and the workforce scores, respectively. Only 47 (or 29.7 per cent)
out of the 158 examined observations had a CG committee for all of the years included
in the sample period. Also, the leverage variable is centered about 17.4 per cent, but
has a standard deviation of 18.2 per cent. In a developing country, corruption may
facilitate taking a loan for a firm with owners that have good connections with bank
managers, regardless of the financial viability of such loan (Al-Ghamdi and Rhodes,
2015). This may explain the presence of some very high values and the positive
skewness of the distribution of leverage.
To understand whether the characteristics of firms that took tangible initiative to
improve their governance system differ from the aggregate sample, we examined the
sub-group of firms that form a governance committee. Table II shows that firms having
governance committee improves governance: namely, they have considerable less
ownership concentration, relatively larger female representation on boards slightly
decreases the cost of equity. The results also show that firms that do not have a
governance committee rely on more independent directors on boards and financially
outperform those having governance committee. This might suggest that firms that
are underperforming are more inclined to enhance their governance system to
improve their financial performance.
Table III shows the correlation matrix of the variables.Interestingly, the simple
correlations with ROA are mostly insignificant, with the exception of workforce score,
firm size and existence of governance committee. The latter is negatively related to
firm profitability. If forming governance committee will solve serious agency problems

PAGE 610
Table III Correlation matrix. Starred entries are significant at the 5% significance level
j SOCIAL RESPONSIBILITY JOURNAL j VOL. 15 NO. 5 2019

Board Board gender Board Owner ESG Workforce Log Board specific Board governance
ROA independence diversity size concentration score score assets Leverage skills committee
ROA 1
Board Independence 0.0437 1
Board Gender Diversity 0.0461 0.0494 1
Board Size 0.0805 0.0065 0.0396 1
Owner Concentration 0.0311 0.1163 0.1008 0.1861* 1
ESG Score 0.0720 0.0263 0.3485* 0.0009 0.3083* 1
Workforce Score 0.2681* 0.0349 0.4125* 0.0051 0.2036* 0.7657* 1
Log Assets 0.2677* 0.1076 0.0498 0.3505* 0.3626* 0.3964* 0.3741* 1
Leverage 0.0691 0.0882 0.0855 0.1082 0.0678 0.1116 0.0697 0.1950* 1
Board Specific Skills 0.0128 0.1132 0.0978 0.0681 0.0326 0.1205 0.0444 0.0962 0.0353 1
Board Governance
Committee 0.1703* 0.1262 0.2470* 0.1324 0.2611* 0.2397* 0.0842 0.3146*0.2107* 0.0946 1
(Huang et al., 2009), then firms with lower profits become more likely to form such a
committee. The negative relationship between governance committee and ownership
and per cent held by strategic investors emphasizes that firms that take governance
seriously tend not to be dominated by specific investors, government or families;
these firms tend to benefit from a more diluted ownership structure, in line with
Abdallah and Ismail (2017). Board composition variables show mixed results,
whereas ESG variables show negative correlation with ROA.
5. Empirical results
Table IV presents the regression results of the baseline specifications for all firms in
the sample post Arab Spring (2012-2016), whereas Table V presents the results only
for the firms that have a CG committee. Both tables show the estimated results of
equation (1). We use ROA as a proxy for firm profitability. We also cluster the error
term by firm and year. Clustering allows the error terms to be correlated within firms
but not between firms and thus provide more accurate standard errors (Petersen,
2009; Cameron et al., 2011). We control for the firm random effect in all the
specifications[2]. The Hausman test shows an insignificant p-value in Table IV,
leading us to adopt the random effects model.
Table IV displays the relationship between rate of ROA with all the dependent
variables, including CG and controls. We find that BC shows mixed correlations with
profitability. For example, independence is strongly negatively correlated with firm
value; the results support stewardship theory (SH1). This sign can possibly reflect the
negative effect of BI when the family and strategic investors have much power, and in
the absence of legal enforcement of rights. In many of the firms in MENA, strategic
investors hold membership positions on the board and may act as the CEO of the firm.
Table IV Estimated effects of CG on firms’ profitability (random effects model) with

control variables, as a check for endogeneity
Independent variables Dep. Var. = ROA
BI 0.0356997** (0.0147)
BGD 0.0631** (0.0286)
BS 0.1807 (0.2790)
BSS 0.0586*** (0.0076)
OWN 0.0214*** (0.0068)
Governance Committee 3.3335*** (0.8974)
ESG Score 0.1829*** (0.0236)
Workforce Score 0.1409*** (0.0306)
Log Assets 2.4990*** (0.3722)
Leverage 0.0738* (0.0413)
Intercept 32.4077*** (7.2309)
Countries 13
Firm RE YES
Year Dummies YES
R-Squared 0.2348
Hausman test ( x 2) 11.55
(p-value) 0.3987
Number of Observations 158
Notes: It presents a panel regression of ROA on our three measures of CG (board characteristics,
ownership and control and ESG) and two control variables size and leverage. Our sample period is
from 2012 to 2016. The dependent variable is Thomson Reuters’s ROA profitability score. Firm and
year dummies are included to control for firm and year specific characteristics. White robust
standard errors are to account for any possible heteroskedasticity. Standard errors (clustered by firm
and year) are within parentheses. The asterisks ***, ** and * denote significance at the 1%, 5% and
10% level, respectively

Table V Estimated effects of CG on firms’ profitability, when a governance committee
exists (random effects model) with control variables, as a check for endogeneity
Independent variables Dep. Var. = ROA
BI 0.0197*** (0.0077)
BGD 0.0355** (0.0165)
BS 0.1889*** (0.0736)
BSS 0.0284*** (0.0089)
OWN 0.02102** (0.0096)
ESG Score 0.0242*** (0.0054)
Workforce Score 0.02304** (0.0112)
Log Assets 0.3095 (0.3779)
Leverage 0.1179*** (0.0276)
Intercept 0.8745 (3.6968)
Countries 13
Firm RE YES
Governance committee YES
Year dummies YES
R-Squared 0.7025
Number of observations 47
Notes: Standard errors (clustered by firm and year) are within parentheses. The asterisks ***, ** and *
denote significance at the 1%, 5% and 10% level, respectively
Hence, they may weigh more heavily than independent directors on the board, as they
may possess more firm specific knowledge and have more at stake in managing the
firm. In such firms, the orientation of ownership and control is tighter, thus
overshadowing the need for outside directors (Muth and Donaldson, 1998). When too
many family members skirmish or drain resources as evidenced by a large board size,
financial performance usually suffers (Miller and Breton-Miller, 2006). BGD is
positively correlated with firm value. This is supported in the literature by similar
results (Arayssi et al., 2016). BSS show a negative correlation with ROA; this result
can be reconciled with the view that large boards are more likely to have board
members that fail to co-ordinate decisions very well or fail to trust each other. This
may prevent synergies to operate from their specific skills (Harris and Helfat, 1998).
Owner concentration displays a positive relationship with ROA, also in contrast with the
second hypothesis (AH2). These results seem to suggest that owners, whether family
members or holding companies or government entities, add value to the firm through
their increased monitoring and involvement on the board (Andres et al., 2007).
Moreover, because their investment is considerable, large shareholders usually suffer a
greater loss from expropriation than smaller shareholders. Consequently, large
shareholders have an incentive and an ability to better monitor management
effectiveness, thus resulting in an increase in firm performance (Cai et al., 2016). This
result is in line with the stewardship theory (SH2).
ESG score is positively correlated to profitability of the firm, as expected from the literature
(Klapper and Love, 2004). Workforce score is negatively correlated with ROA. This
relationship runs contrary to what is expected in Yoon and Suh (2003). Perhaps this result
indicates that the workforce’s role in the CG in MENA firms has not been large. Further,
existence of CG committee is found to be negatively correlated with profitability. This result
agrees with the fact that companies with low level of governance, one that impedes
performance, tend to form such a committee. Therefore, results agree with the third
hypothesis that there are mixed effects of ESG on firm value. Control variables firm size and
leverage show negative correlation with ROA. This is in agreement with results in Klein et al.
(2005) and Perrini and Minoja (2008) that deny the fourth and fifth hypotheses, respectively,
of ambiguous effects on firm value.

Table V displays the estimation of profitability in equation (1) when a governance
committee exists. In this table, it is worth noting the effect that the Arab Spring had on
improving transparency and governance, indicated by the reasonable size (30 per
cent) of firm-year instances that mandated a CG committee, and by the large
improvement of R-squared in this table, from 23 to 70 per cent. The inclusion of this
committee, an important moderator that is responsible for overseeing the BOD, tends to
strengthen the role of main board characteristics, such as BI and BS. Independence
becomes positively correlated with profitability: a less independent board is less
expected to approve a governance committee to oversee itself (Huang et al., 2009).
Therefore, in this group of firms that voluntarily form a CG committee, boards are not
only strongly independent but contribute to positive returns by taking bold managerial
decisions, exerting more diligence in thwarting fraud and helping to protect against
likely litigation (Abdallah and Ismail, 2017). This seems to align our earlier results about
BI more with the hypothesis under agency theory (AH1).
In this estimation, note that the correlation of ROA with BS becomes stronger,
underscoring the fact that such firms already have a larger board; this increases the
chances of forming the CG committee. This correlation highlights the detrimental role
of the large BS on profitability. Remarkably, owner concentration which is lower in
these firms, flips the correlation sign to negative. Conceivably, this may occur
because of the duplicate function of a governance committee and ownership
concentration in the context of closer monitoring of the firm’s performance. This
confirms our hypothesis (AH2).
ESG score also changed its correlation sign with ROA from positive to negative, in
contrast with Klapper and Love (2004). This can result if the existence of CG
committee confounds the effect of this score. The workforce score flips correlation
signs becoming positive, in line with Yoon and Suh’s (2003) effect of workforce
satisfaction on profitability. Henceforth, results still agree with the third hypothesis
that there are mixed effects of ESG on firm value. Finally, leverage becomes positively
correlated and significant with ROA; this can emphasize that well-governed firms find
leverage to add to profits. This effect is supported by Stiglitz (1985) as discussed in
the fifth hypothesis.
It can be a useful check on the results obtained in Table IV, to examine whether cost
of equity is lower in firms with good CG post- Arab Spring as illustrated in equation
(2). The results of this estimation are shown in Table VI. Relationships between
the dependent and independent variables are expected to be reversed from those
in equation (1). Several independent variables are not statistically significant; this
lowers the R-squared in this estimation. BSS is positively correlated with cost of
equity. This result stresses further the fact that firms in this region have a large BS on
average that does not yield sufficient synergies, which consequently translates into
higher costs.
Owner concentration is negatively correlated with cost of equity, but insignificant with cost
of equity. In contrast, Ezat and El-Masry (2008) show that when the ownership is spread,
companies disclose more information electronically, hence decrease owners’ information
costs and assists them monitor management performance. The correlation between
workforce score and cost of equity is positive and significant, reflecting the actual cost of
such workers’ programs to the firm.
We rerun the regressions using ROE instead of ROA to insure the robustness of our
results. The reported findings are largely in line with the earlier models, supporting the
relationships between board structure and firm performance. Table AI shows that
board independence and board specific skills negatively influence firm performance.
In contrast, when firms with sound CG, gauged by the existence of a governance

Table VI Estimated effects of CG on firms’ cost of equity capital (random effects model)
with control variables, as a check for endogeneity
Independent variables Dep. Var. = WACE
BI 0.0017 (0.0088)
BGD 0.0484 (0.0456)
BS 0.0476 (0.0415)
BSS 0.0457*** (0.0054)
OWN 0.0093 (0.00724)
Governance Committee 1.0076 (1.1466)
ESG Score 0.0856*** (0.0064)
Log Assets 1.5166 (1.3448)
Leverage 0.00086 (0.0012)
Intercept 26.9473** (13.1093)
Countries 13
Firm RE YES
Year dummies YES
R-squared 0.2047
Note: It presents a panel regression of WACE on our three measures of CG (board characteristics,
ownership and control and ESG) and two control variables size and leverage. The dependent
variable is Thomson Reuters’s Weighted Average Cost of Equity cost score. Firm and year dummies
are included to control for firm and year specific characteristics. Standard errors (clustered by firm
and year) are within parentheses. The asterisks ***, ** and * denote significance at the 1%, 5% and
10% level, respectively
committee are examined in Table AII, board independence and board gender
diversity turn to be positively influencing firm performance. These findings suggest
that in cases where governance is well pronounced the dynamics of the agency
theory apply.
CG in developing nations has been considered as volatile and frail despite being
explicitly important in the MENA region (Braendle et al., 2013; Denis and McConnell,
2003; Klapper and Love, 2004). To confirm these findings, we further investigate CG’s
effect and we discover that it can play a dual role in these economies: first, when firms
are tightly owned, there is an absence of the conservatively recognized infrastructure
that deals with CG issues. These firms then tend to substitute high ownership
concentration for the CG mechanism in monitoring and controlling management.
Second, we show, similarly to Heracleous (2001) and Okpara (2011), that CG’s role is
reinstated in MENA when ownership of firms is widespread, by the fact that they elect
to form a governance committee. For the whole sample, ESG plays an important role,
in line with Allegrini and Greco (2013), Klapper and Love (2004) and Jizi (2017).
Hence, we also recommend continuous development of ESG disclosures, seeing how
this can boost the firms’ level of profits through developing a social rapport with their
communities.
Overall, the results in this paper confirm the theory that CG matters for performance
even in the context of weak governance, law enforcement and political changes. Also,
they reaffirm the findings that forming a CG committee is more likely to occur when
agency problems are important and profitability is lower, as shown consistently in the
sign and significance of the explanatory variables. Thus, the decision to form a CG
committee consolidates the role of BC and ownership control in the firm, and
remedies the relationships with profitability to conform more closely to our stated
hypotheses under the assumptions of the agency theory. Furthermore, using ROA and
ROE as financial performance measures, we find a significant impact for CG’s

adoption on firms’ financial performance in the listed MENA companies unlike Buallay
et al. (2017) who studied only the Saudi stock exchange.
6. Conclusion
In this paper, we explored MENA firms and found that strategic investors hold
membership positions on the board, and major shareholders, such as family
members, individuals, corporations or government, usually administer tighter control
of firms. It was found that through their specific knowledge and their large stake in the
firms, they are better able to align ownership and control, thus generating profits.
When families and/or governments own firms, the assumptions of agency theory may
not apply, as good governance processes are not universal but hinge on market and
firm characteristics. In this setup, stewardship theory offers a better explanation of
major shareholders’ behavior, actively participating and sometimes chairing the BOD
and providing service and advice rather than monitoring and control (Muth and
Donaldson, 1998). In this context, outside directors with less stake in the firm may
become less valuable. Moreover, independent directors possessing less firm specific
knowledge and less financial stake, may lower firm efficiency by diverting managers
and by making them focus on more immediate goals, thus imposing a burden on the
board and on the company’s bottom line.
This paper contributes to the existing literature on the CG and firm profitability by
examining the role of BC, ownership structure and ESG in MENA firms under the
stewardship theory (Donaldson and Davis, 1991; Miller and Breton-Miller, 2006). We
find that, in general, the stewardship that views managers as highly motivated and
use their own discretion to perform helps to explain the ownership substituting for
governance. Then it becomes easy to see why board independence, size and
leverage contribute negatively to firm profitability: they have been overridden by the
ownership structure. In this scenario, ownership (being closely related to board
membership) concentration enhances profits. ESG, which is sanctioned by the
owners, turns out to naturally promote profitability.
When the sample is split along the existence of CG committee, we find that firms with low
ownership concentration and low profitability tend to form such committee in an effort to
bring in good governance; this poses the possibility that companies with weak governance
tend to form such a committee to compensate for their income deficiency. As a matter of
fact, for the companies that decide to form a CG committee, we discover that the BI and
BGD become positive contributor to profits and the BS takes a definite negative role in
explaining profitability, realigning the effect of this variable with agency theory expectations.
Many of these same variables are also relevant for explaining the capital structures in the
USA and European countries, despite the profound differences in institutional factors
between these countries. Hence, we notice that a firm is more likely to form a governance
committee to compensate for its severe agency problems. Furthermore, the firms that
delegate some CG duties to a specific board committee could improve the effectiveness of
board monitoring.
Although the Arab Spring has overall brought some added transparency, MENA
region’s fragile states and high ownership concentration have limited the role of the
private sector and CG, and prohibited entrepreneurship and innovation. This part of
the world can still benefit from the market discipline to enhance management, by
enforcing existing legislation and reforms. Firms should be encouraged, through
legislation, to reduce BS, as this tends to depress profits. Another necessary
improvement would be to require the formation of a governance committee that can
mitigate the heavy weight of existing shareholders in management, and improve
systematic monitoring. When companies display diluted ownership, design of BC
should focus on more co-operation among board members and inclusion, especially

with independent directors. This may increase the synergies occurring to the firm of
BSS. Therefore, the stewardship angle may also provide suggestions in this case to
board structures which trust insiders or allied investors (Sundaramurthy and Lewis,
2003). Further research can explore whether forming a CG committee may substitute
or complement the role of major shareholders in managing the firm.
The political connectedness of some board members can be studied in further research to
determine whether it affects firm profitability. It would be interesting to see if the inclusion of
political connected board members reinforces the role of governance in the MENA firms’
and try to examine this relationship using the theories proposed in this study, namely the
stewardship and/or agency theories.
Notes
1. The Saudi Company Law, issued by the Royal Decree No: 6 dated 1965, Al-Zahrani, Y. A.
(2013). Rights of shareholders under Saudi company law (Doctoral dissertation).
2. It is should be noted that we run the same specifications shown in Tables IV and V but using a
different proxy for firm profitability, that is, we use the rate of return on equity and find very close
results. The estimated coefficients are presented in Tables AI and AII separately for the baseline
model and for firms with governance committee, respectively.
References
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Appendix
Table AI Estimated effects of CG on firms’ profitability (random effects model) with

control variables, as a check for endogeneity
Independent variables Dep. Var. = ROE
BI 0.0722*** (0.0234)
BGD 0.0589 (0.1015)
BS 0.0502 (0.2376)
BSS 0.0969*** (0.0271)
OWN 0.0138 (0.1416)
Governance Committee 4.0676** (1.6607)
ESG Score 0.1847*** (0.0405)
Workforce Score 0.0686** (0.0271)
Log Assets 2.0523** (0.8329)
Leverage 0.1490*** (0.0254)
Intercept 38.5987*** (8.5906)
Countries 13
Firm RE YES
Year dummies YES
R-squared 0.1100
Notes: It presents a panel regression of ROE on our three measures of CG (board characteristics,
ownership and control, and ESG) and two control variables size and leverage. The asterisks ***, **
and * denote significance at the 1%, 5% and 10% level, respectively
Table AII Estimated effects of CG on firms’ profitability, when a governance

committee exists (random effects model)
Independent variables Dep. Var. = ROE
BI 0.1901*** (0.0228)
BGD 0.3295*** (0.0724)
BS -0.0902 (0.3092)
BSS -0.0770** (0.0329)
OWN -1.6530*** (0.0409)
ESG Score -0.07816 (0.0721)
Log Assets 6.8772*** (0.7966)
Leverage 0.0745 (0.1032)
Intercept -57.1961*** (10.8413)
Countries 13
Firm RE YES
Governance Committee YES
Year Dummies YES
R-squared 0.5051
Number of Observations 47
Note: The asterisks ***, ** and * denote significance at the 1%, 5% and 10% level, respectively
Corresponding author
Mohammad Issam Jizi can be contacted at: mohammad.jizi@lau.edu.lb
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Does Corporate Governance Spillover Firm

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Does corporate governance spillover ﬁrm

performance? A study of valuation of

Abstract Mahmoud Arayssi and

1. Introduction JEL classiﬁcation – G32, F65

Despite the significant increase in privatization, economic liberalization and diversification

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Table I Variables deﬁnition

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4.2 Empirical methodology

ROAit ¼ ai þ b 1 BCit þ b 2 OWNit þ b 3 ESGit þ b 4 SIZEit þ b 5 LEVit þ « it (1)

WACEit ¼ ai þ b 1 BCit þ b 2 OWNit þ b 3 ESGit þ b 4 SIZEit þ b 5 LEVit þ « it (2)

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4.4 Descriptive statistics

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Table IV Estimated effects of CG on ﬁrms’ proﬁtability (random effects model) with

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Gruszczynski, M. (2006), “Corporate governance and financial performance of companies in Poland”,

Heracleous, L. (2001), “What is the impact of corporate governance on organisational performance?”,

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Table AI Estimated effects of CG on ﬁrms’ proﬁtability (random effects model) with

Table AII Estimated effects of CG on ﬁrms’ proﬁtability, when a governance

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