Do agency conflicts between managers

and shareholders affect corporate

risk management and financial
performance of Saudi firms?
Lamia Jamel, Hanadi Eid Albogami, Mazen Abduljalil Abdulaal and Nuha Ahmed Aljohani

Lamia Jamel (lajamel@ Abstract

yahoo.fr) is an assistant Purpose – The purpose of this paper is to examine the impact of agency conflicts between managers
professor, Hanadi Eid and shareholders on corporate risk management and financial performance of Saudi firms listed in the
Albogami (hbqomy@ Saudi Stock Exchange Tadawul.
taibahu.edu.sa) is a Design/methodology/approach – To investigate the effect of agency conflicts between managers and
lecturer, shareholders on corporate risk management and financial performance, we use a sample of 180 Saudi
firms listed in the Saudi Stock Exchange Tadawul during the period from 2009 to 2018. Econometrically,
Mazen Abduljalil Abdulaal
we employ Vector Autoregressive (VAR) and General Linear Model (GLM) techniques as an appropriate
(Mabdulaal@taibahu.edu.
methodology.
sa) is a lecturer and
Findings – Our findings show that the risk level of the last year increase the corporate risk management
Nuha Ahmed Aljohani
and the performance of Saudi firm. We remark that the separation amongst control and ownership
(Nuhaahmed-1@hotmail.
generates agency conflicts amongst managers and shareholders which can affect their behavior in
com) is a lecturer, all in the decision-making and performance of the Saudi firms. Thus, the conflicts of interest arise from the
Department of Finance and differences among the work horizon, the risk assumed, the performance of enterprises, and the level of
Economics, College of remuneration desired by the managers and shareholders in the case of Saudi firms.
Business Administration, Originality/value – The main contributions of our paper prove that the deepen the study of agency costs
Taibah University, linked to a shareholding structure through the analysis of monitoring, obligation, and opportunity costs in
Medinah, Saudi Arabia. the Saudi firms.
Keywords Risk management, Managers, Shareholders, Financial performance, Agency conflicts
Paper type Research paper

1. Introduction
Access to information is a growing need. However, in reality, this information is poorly
distributed among the various market players. Due to this information asymmetry, the
distribution becomes unfair between the various partners of the company with divergent
interests. Information asymmetry is a situation where one agent has information that another
does not. This situation is often materialized by an agency relationship where the principal
(principal) asks an agent (mandatory) to perform an action on his behalf. Therefore, the
agent with more information may be tempted to act in his own interest and not that of the
principal. There follows an agency conflict.
Several studies have shown that adoption of IFRS leads companies to disclose more and
better information (Dumontier and Maghraoui, 2006; Lakhal, 2015; Thomton, 2015). This
JEL classification – G32, D81, should reduce the problem of information asymmetry between the different stakeholders of
G34, O16 the company.

PAGE 58 j JOURNAL OF INVESTMENT COMPLIANCE j VOL. 22 NO. 1 2021, pp. 58-73, © Emerald Publishing Limited, ISSN 1528-5812 DOI 10.1108/JOIC-11-2020-0044
The agency theory or mandate theory emphasizes the potential divergences of interests
between the various stakeholders of the company (managers, shareholders [. . .], which
maintain varied relationships and many of which are frequently a source of conflict
(Dumontier and Maghraoui, 2006; Lakhal, 2015; Thomton, 2015).
Various corporate governance mechanisms are proposed to resolve issues of diverging
interests of managers and shareholders and thereby reduce the agency costs associated
with such conflicts. The ownership structure is only one part of the governance system that
can affect the value of the firm.
Several studies have been carried out in order to empirically highlight the relationship
between the ownership structure and the performance of firms. In particular, the financial
literature has devoted much attention to two relationships. First, several works study the
relationship between the concentration of capital and the performance of companies. For
example, Hill and Snell (1988) and McConnell and Servaes (1990) conduct their study on
American companies. The test of this relationship for firms in the United Kingdom (UK) is
presented in the work of Leech and Leahy (1991). The case of Japanese companies is
studied by Kaplan and Minton (1994) and Morck et al. (2000). Finally, Garton and Schmid
(2000) and Lehmann and Weigand (2000) study the case of German companies.
Then, other work has focused on studying the relationship between managerial ownership
and firm performance. In this case, these studies seek to test the hypotheses of
convergence of interests and entrenchment. Thus, the examination of this relationship for
the case of American companies is carried out by Morck et al. (1988), McConnell and
Servaes (1990), Han and Suk (1998), Holderness et al. (1999). While Short and Keasey
(1999) study the relationship for the case of UK firms.
It is within this framework that our research falls. It centers around the principal question: to
what extent does the ownership structure impact the performance and risk management of
Saudi Arabian companies?
Following these theoretical developments and relative to the question asked, the objective
of this research is to empirically test, for the case of Saudi companies, the effect of
ownership-structure conflict on performance and risk management.
This paper aims to examine the impact of agency conflicts between shareholders and
managers on corporate risk management and the financial performance of 180 Saudi
companies listed on the Saudi Stock Exchange (Tadawul), during the period 2009–2018.
Our sample represents 95% of the total market capitalization in Tadawul from 17 different
sectors. We use a Vector Autoregressive (VAR) and Generalized Linear Model (GLM) as an
appropriate econometric methodology. We utilize for corporate risk management the ratio of
total debt to total assets (FRISK) and return on equity (ROE) for financial performance, both
as endogenous variables, with 13 indicators as exogenous variables.
Our empirical findings show that the level of risk on date (t-1) has a positive impact on risk
management on date t. However, the level of risk on date (t-2) has a negative effect on risk
management on date t. Additionally, we find that the number of directors on the board has a
negative impact on corporate risk management. This result indicates how the various
decisions issued by various directors can negatively affect the corporate risk management.
We remark that annual sales have a significant impact on corporate risk management of
Saudi companies during the period of study. On the other hand, for the financial
performance of Saudi firms, the study shows that the variable that measures corporate risk
management of Saudi firms on (t-1) has a negative effect on financial performance on
date t. Also, we find that the risk level in the previous year can affect the risk and
performance of Saudi firms in the present year.
Finally, we can conclude that the separation between control and ownership creates
agency conflicts among managers and shareholders, which can influence their behavior in

VOL. 22 NO. 1 2021 j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 59

 decision-making and the performance of their enterprises. We can find that conflicts of
interest arise from the differences between the work horizon, the risk assumed, the
profitability of enterprises, and the level of remuneration desired by the managers and
shareholders. (PLEASE ADD HERE A PARENTHETICAL DEFINITION OF WHAT YOU MEAN
BY WORK HORIZON.) Our empirical results have shown that shareholder-controllers, in
view of their power over the management of the company, can appropriate profits at the
expense of small shareholders, through off-market transactions with controlled entities.
The rest of our paper is organized as follows. Section 2 presents a literature review related
to the impact of agency conflicts between managers and shareholders on corporate risk
management and financial performance. Section 3 describes the econometric methodology
used in this paper. Section 4 defines the data utilized in this article. Section 5 is devoted to
the empirical findings of the impact of agency conflicts between managers and
shareholders on corporate risk management and financial performance in the case of Saudi
firms. Finally, Section 6 concludes and presents policy implications of our study.

2. Literature review
Many empirical studies have sought to highlight the link between the structure of ownership
and the performance of firms. The results obtained are contradictory. Some works have
shown a linearity of the relationship while others have demonstrated a non-linear
relationship between performance and ownership structure (managerial ownership). Jensen
and Meckling (1976) consider that the greater the share of capital held by managers, the
weaker the differences of interest between shareholders and managers. Indeed, when the
interests of managers coincide firmly with those of shareholders, conflicts and therefore
agency problems will be reduced. These authors note that managerial ownership can
reduce the tendency of managers to take advantage of their position, to expropriate
shareholders’ wealth and to engage in decisions that do not maximize the value of the firm.
Hence the hypothesis of convergence of interests, which suggests that the value of the firm
increases if the percentage of capital held by managers increases.
However, Morck et al. (1988) show that there is a non-monotonic relationship between the
participation rate of the board of directors, represented by the capital held by the directors,
and Tobin’s Q (the market value of a company divided by the replacement cost of its
assets), by referring to a sample of 371 Fortunes 500 firms in 1980. This increases from 0 to
5%, then decreases between 5 and 25%, and finally increases again beyond 25%. These
authors confirm that this nonlinear relationship comes from the coexistence of two
contradictory hypotheses, namely the hypothesis of “the convergence of interests” and that
of “managerial roots”.
The effect of the concentration of capital on the performance of the firm is theoretically
complex and empirically ambiguous. In fact, many studies have found a positive influence
of the presence of majority shareholders on performance. While other work has concluded
that there is no relationship between concentration of capital and performance.
Berle and Means (1932) suggest the existence of a positive and linear relationship between
the concentration of capital and the value of the firm. In this context, the results of the
contribution of Shleifer and Vishny (1986) to the property structure literature confirm the
previous conclusion. They show the importance of the role played by large shareholders.
These theoretical propositions suggest a positive relationship between concentration of
capital and performance.
From another point of view, the ownership structure has no influence on the performance of
the firm. In other words, all ownership structures are equivalent. Firm performance is
essentially constrained by the environment and the operating conditions of the company. In
this context, Demsetz and Lehn (1985) examine the influence of the presence of majority
shareholders on performance for the case of 551 American firms in 1980. They classify

PAGE 60 j JOURNAL OF INVESTMENT COMPLIANCE j VOL. 22 NO. 1 2021

concentrated ownership into three groups: all investors, institutional investors and
shareholders belonging to the founding family. The results show that the relationship
between the concentration index and the rate of return on equity is neither significant nor of
expected sign (positive).
More recently, Shabou (2003) examines the impact of the concentration of capital on the
financial performance of a sample of 64 Tunisian companies. He concludes that the
concentration of capital has an insignificant impact on performance. Nevertheless,
significant differences appear according to the nature of the control; companies controlled
by financial institutions perform less well than companies controlled by individuals.
The classical theory explains that a firm is composed of the unification of the different
factors of production who have different interests that motivates them. The survival of these
factors of production affirms the success of an organization (Fama, 1980). The managers
are the risk-takers in the organization, while the real owners of the organization are the risk-
bearers. Hence, the risk-bearers are the ones who suffer greater consequences once the
team fails to work as expected. Hence conflicts will result to higher losses to the
shareholders. On the other hand, the manager will never experience direct consequences
from the group’s downfall. Generally, according to this theory, the more the conflicts
between the two groups, the less they focus on the problem solution.
On the other hand, on the fundamental relationship between risk-bearing and decision
making, Fama and Jensen (1983), establish the consequences of conflict when managers
own part of the wealth and when they do not own any. The conflict separates decision
management from management control entirely if the management team is composed of
outsiders. The progress of any agency depends on the risk that management takes. Hence,
in case they are outsiders, they are likely to take unprecedented risk and poorly manage it
since they do not suffer direct consequences. On the other hand, insiders who are
shareholders may realize the conflict, making them risk averse. They have a double loss,
and they prefer a constant situation. This will hinder the progress of the organization.
Thirdly, other theoretical approaches on firm ownership and its capability in risk
management include the size and capability of the firm. According to Demsetz and Lehn
(1985), some of the factors that define the agency ownership include the size, profit rate
stability, and the level of regulation by the financial institution. Therefore, small firms have
unstable profitability, and regulated financial institutions require more control oversight.
Hence such firms require less conflict between shareholders and management. On the
other hand, firms that are profit stable, large, and not under the control of any financial
institution can accommodate the conflict, and it can have an insignificant effect on the
profitability of the organization.
According to the research done by Fleming et al. (2005), one of the significant factors is
associated with the separation of ownership and control. Shareholders are the owners of the
organization while management is obliged to control the running of it. Using research done
among 3800 agencies in Australia, Fleming et al. (2005) affirm that there are direct
relationships among shareholders and management conflict and the cost of an
organization. Ang et al. (1999) also affirm a substantially high-cost relationship associated
with this conflict. After observing 1708 corporations, Ang et al. (1999) come up with three
conclusions on cost. To begin with, it is higher when managed by outsiders. Additionally, it
is inversely related to managers’ ownership. Thirdly the higher the number of non-manager
shareholders, the higher the cost. Finally, with better monitoring by the bank, the cost
always declines. Generally, from the above studies, the conflicts encourage high cost in
management activities including risk management.
Amamou and Ben-Ahmed (2019) test ten Tunisian banks for five years from the year 2000 to
the year 2015. The study was focused on establishing the best way to reduce conflict. The
study found out that when the managerial group is among the shareholders, they will most

VOL. 22 NO. 1 2021 j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 61

 likely take lower risks. On the other hand, in case the management group is mainly
comprised of outsiders, more risks are taken. The reason for this is that as an outsider, the
manager is ambitious on career development without profit concern. On the other hand, as
an insider the manager is also critically concerned with profitability; hence he has the same
interest as other shareholders. This idea is supported by the study done by Islam et al.
(2020), who argues that more effective risk management is associated with managers who
hold the company’s shares. Therefore, to minimize conflict the company should sell some of
its shares to managers.
A recent study done by Salehi et al. (2020) that involved the regression of time series data
from 2011 to 2015 showed that managers’ power is insignificant to competition and
investment. The study also affirmed that competition discourages risk-taking among
institutions. Generally, the organization decides on risk-taking, and the ability of risk
management depends on the external business environment and not internal factors.
Hence a conflict will have no major effect on competition and investment. As long as
managers do their work and investors do not interfere, the conflict has no effect. However,
Agrawal and Knoeber (1996) contradict this notion by arguing that the directors are
associated with the firm’s investment decisions that determine profitability of the
organization. They also play a significant role in the competition of the organization. Hence,
the conflict with organization owners affect investment and profitability.

3. Econometric methodology
We explain in this section the econometric methodology and all utilized indicators in this study.
We employ a Vector Autoregressive (VAR) and Generalized Linear Model (GLM) to examine
the impact of agency conflicts between managers and shareholders on corporate risk
management and financial performance of 180 Saudi firms listed in the Saudi Stock Exchange
Tadawul during the period of study from 2009 to 2018. The GLM is used to confirm the results
showed by the VAR model. This is a form to test the robustness of our model.
For the VAR model, let a vector process {yt}t[Z of dimension (k,1) admit a representation
VAR(p):

yt ¼ c0 þ A1 yt1 þ    þ Ap ytp þ vt (1)

AðLÞyt ¼ c0 þ vt (2)

Where, A0 = Ik and Ap = 0k
The matrices Ai, Vi [ [1, p] are of dimension (k, k). The innovation vestor vt is I.I.D (0k,X) and
where X is a positive significant symmetric square order matrix (k). The innovation vector
should appease the next properties:

E ðvt Þ ¼ 0k (3)

0
  X; j ¼ 0
E vt vt ¼ (4)
0; j 6¼ 0

The model VAR(p) is following:

y1t ¼ a10 þ a11

1
y1;t1 þ a12
1
y2;t1 þ    þ a1k
1
yk;t1
þ a11
2
y1;t2 þ a12
2
y2;t2 þ    þ a1k
2
yk;t2
.. (5)
.
p p p
þ a11 y1;tp þ a12 y2;tp þ    þ a1k yk;tp þ v1t

PAGE 62 j JOURNAL OF INVESTMENT COMPLIANCE j VOL. 22 NO. 1 2021

 y2t ¼ a20 þ a21
1
y1;t1 þ a22
1
y2;t1 þ    þ a2k
1
yk;t1
þ a21
2
y1;t2 þ a22
2
y2;t2 þ    þ a2k
2
yk;t2
.. (6)
.
p p p
þ a21 y1;tp þ a22 y2;tp þ    þ a2k yk;tp þ v2t

Once Again, we can show the matrix form while conforming with the following scriptures:

0 1 0 1 0 1
y1t a10 i
a11 i
a12 ... i
a1k
B C B C B C
By C B a0 C B ai i C
B 21 a22 . . . a2k C
i
B 2t C B 2C
B C B C B C
B. C B. C B . .. .. C
B .. C B .. C B .. . . ... C
B C B C B C
yt ¼ B C B C
B y Cc0 ¼ B a0 CAi ¼ B i
B
i C
C
B jt C B j C B j1
a a i
. . . a jk C
B C B C B j2
C
B. C B C B C
B. C B .. C B .. .. .. .. C
B. C B. C B . . . . C
@ A @ A @ A
ykt ak0 i
ak1 ak2i
. . . akk i
i2½1;p 
0 1 0 1
y1;ti v1t
B C B C
By C Bv C
B 2;ti C B 2t C
B C B C
B. C B. C
B .. C B .. C
B C B C
yti ¼ B
B
C
C vt ¼ B
Bv C
C (7)
B yj;ti C B jt C
B C B C
B. C B. C
B. C B. C
B. C B. C
@ A @ A
yk;ti vkt
i2½1;p 

Therefore, we come to enlist the general matrix writing of a multivariate VAR (p) which is
characterized in its reduced structure:

X
p X
p
yt ¼ c0 þ Ai yti þ vt ¼ c0 þ Ai Li yt þ vt (8)
i¼1 i¼1

To estimate our model and to test the effect of agency conflicts between managers and
shareholders on corporate risk management and financial performance of Saudi firms
through the period of study from 2009 to 2018, we use corporate risk management (FRISK)
and financial performance (ROE) as endogenous variables, and we use 13 indicators as an
exogenous variables. The definition of all employed indicators is summarized in Table 1.
In statistics, the generalized linear model (MLG) often known by the English initials GLM is a
flexible generalization of linear regression. The GLM generalizes linear regression by allowing
the linear model to be linked to the response variable via a link function and by allowing the
amplitude of the variance of each measure to be a function of its expected value.
Generalized linear models were formulated by Nelder and Wedderburn (1972) as a means of
unifying other statistical models including linear regression, logistic regression and Poisson
regression. They propose an iterative method called iteratively reweighted least squares
method (in) for the estimation of the maximum likelihood of the parameters of the model.
Maximum likelihood estimation remains popular and is the default method in many statistical
calculation software applications. Other approaches including Bayesian statistics and the
least squares method suitable for stabilized variance responses have been developed.
Also, Table 1 provides a summary of the average market capitalization across the period of
study, the number of firm years and percentage of the sample for each of the 17 sector

VOL. 22 NO. 1 2021 j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 63

 Table 1 Variable definitions
Variable Definition

FRISK The ratio of total debt to total assets

ROE Return on Equity (ROE) is the measure of a company’s annual return (net
income) divided by the value of its total shareholders’ equity
ACOST ACOSTS refers to our agency cost proxies (AUR and DER)
AUR The ratio of annual sales to total assets (asset utilization ratio)
DER The ratio of discretionary operating expenses to total (discretionary
operating expense ratio)
BSIZE The number of directors on the board
BLOCK The percentage of ordinary shares held by shareholders who own 5% or
more of these shares
DFIN Dummy variable equals to 1 for financial firms and 0 otherwise
FSIZE Natural log of annual sales
INDUSTRY A set of dummy variables for 17 industry classifications (refer to Table 2)
INSOWN The percentage of ordinary shares held by the board
IODIR The ratio of the number of independent outside directors to the total
number of directors on the board
LSIZE Natural log of total assets
MCAP The ratio of the book value of assets less shareholder equity plus the
market value of equity to the book value of assets
GDP Gross domestic product per capita
Source: Own elaboration

Table 2 Sample firm industry classifications

No. Sector No. of firms in the sector % of firm sample

1 Energy 5 3
2 Materials 42 23
3 Capital Goods 12 7
4 Commercial & Professional Svc 3 2
5 Transportation 5 3
6 Consumer Durables & Apparel 16 9
7 Media and Entertainment 2 1
8 Retailing 8 4
9 Food & Staples Retailing 16 9
10 Health Care Equipment & Svc 7 4
11 Pharma, Biotech & Life Sciences 1 1
12 Banks 11 6
13 Diversified Financials 4 2
14 Insurance 32 18
15 Telecommunication Services 4 2
16 Utilities 2 1
17 REITs 3 2
Total 17 180 100
Source: Own elaboration

classifications in the Saudi Stock Exchange Tadawul. Our sample accounts for over 95% of
the total market capitalization in the Saudi Stock Exchange Tadawul.

4. Data
This study aims at empirically examining the influence of agency conflicts among managers
and shareholders on corporate risk management and financial performance of Saudi firms
listed in the Saudi Stock Exchange Tadawul through the period of study from 2009 to 2018.
We employ annual data obtained from Bloomberg databases. Table 3 summarizes the
descriptive statistics of the indicators employed in this paper. From this table, we can

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 Table 3 Descriptive statistics
ACOST BSIZE BLOCK DFIN FRISK FSIZE GDP INDUSTRY INSOWN IODIR LSIZE MCAP ROE

Mean 22.01566 8.602115 0.435899 0.261547 0.999865 4.201854 3.203904 0.117016 6.647746 4.119644 3.292594 2.067010 0.076228
Median 10.48226 10.00000 0.384615 0.000000 1.000000 4.200466 3.652482 0.088889 8.000000 4.000000 3.173189 1.123687 0.077607
Maximum 335.6186 15.00000 1.000000 1.000000 1.000000 4.595573 9.996858 0.227778 13.00000 8.000000 7.881392 285.2093 20.18958
Minimum 0.002546 1.000000 0.052632 0.000000 0.985876 3.806410 2.059268 0.005556 1.000000 0.000000 1.280679 0.000000 83.16731
SD 31.01554 2.550221 0.167660 0.439599 0.001229 0.112251 3.196155 0.078876 2.609732 1.140292 0.877528 10.51258 2.239254
Skewness 3.341860 0.700053 0.588497 1.085167 9.787957 0.132084 0.371211 0.272359 0.578319 0.100025 0.842202 21.60797 27.76538
Kurtosis 20.76472 2.343909 2.175757 2.177587 99.64153 2.943151 3.048788 1.470836 2.465313 2.699197 3.601342 500.0034 1072.008
Jarque-Bera 26974.27 179.0075 154.5939 403.3299 727994.7 54.67128 41.44871 197.3001 121.5745 9.771352 239.5122 18634891 85796420
           
Probability 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.007554 0.000000 0.000000 0.000000
Obs. 1797 1797 1797 1797 1797 1797 1797 1797 1797 1797 1797 1797 1797
Notes: This table reports the descriptive statistics of all indicators used in this paper. We employ annually data for Saudi firms during the period from 2009 to 2018. Statistical implication at the threshold level of 1% is denoted
by 
Source: Own Elaboration

VOL. 22 NO. 1 2021

j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 65
 observe that on average the higher value is for ACOST (22.01566) followed, respectively, by
BSIZE (8.602115), INSOWN (6.647746), FSIZE (4.201854) and IODIR (4.119644).
For the two statistics of skewness (asymmetry) and kurtosis (leptokurtic), we can remark
that all variables employed in our paper are characterized by non-normal distribution. The
negative sign of the skewness coefficients indicates that the variables BSIZE, FRISK,
INSOWN, IODIR and ROE are skewed to the left and it is far from being symmetric for all
variables. However, the skewness coefficients suggest that the rest of variables are skewed
to the right and it is far from being symmetric for all variables. Also, the Kurtosis coefficients
confirm that the leptokurtic for all variables employed in this paper show the existence of a
high peak or a fat-tail in their volatilities.
Based on the positive sign of estimate Jarque-Bera coefficients, we can reject the null
hypothesis of normal distribution of the variables used in our study. Then, the high value of
Jarque-Bera coefficients reflects that the series is not normally distributed at the level of 1%.
Finally, and based on the three statistics; skewness, kurtosis and Jarque-Bera, we can
conclude that all variables employed in this paper are not normally distributed at the level of 1%.
Also, we examine the correlation among all employed indicators. Furthermore, Table 4
summarizes the estimation coefficients of the Pearson correlation matrix among all indicators
used in this study. The empirical findings revealed in this table indicate that all estimating
coefficients are inferior to the tolerance limit of Pearson (0.7), which doesn’t cause problems
in estimating the model used. Since we do not have a correlation problem, in this case we
can continue our study, which is based on a set of econometric tests and estimates.
This paper aims to examine the influence of agency conflicts among managers and
shareholders on corporate risk management and financial performance of Saudi firms
which requires stationarity tests to determine the order of integration of each series. The
results of the Levin-Lin-Shu test applied to the used variables are shown in Table 5 for the
case of Saudi firms.
Thus, the acceptance or rejection of the null hypothesis of the test is based on the value of the
probabilities and statistics relating to the indicated test. These probabilities are compared to a
10% threshold. If these probabilities are less than 10%, then we reject the null hypothesis and
if these probabilities are greater than 10%, then we accept the null hypothesis.
For our case and according to the findings presented in Table 5, we show that all utilized
variables are stationary in level according to the Levin-Lin-Shu test. Thereafter, all the

Table 4 Correlation matrix

ACOST BSIZE BLOCK DFIN FRISK FSIZE GDP INDUSTRY INSOWN IODIR LSIZE MCAP ROE

ACOST 1.000 0.012 0.016 0.306 0.041 0.198 0.029 0.142 0.024 0.028 0.693 0.314 0.053
BSIZE 0.012 1.000 0.474 0.337 0.092 0.150 0.002 0.167 0.580 0.373 0.174 0.033 0.080
BLOCK 0.016 0.474 1.000 0.247 0.100 0.131 0.007 0.155 0.568 0.352 0.152 0.013 0.075
DFIN 0.306 0.337 0.247 1.000 0.065 0.135 0.001 0.153 0.319 0.013 0.060 0.009 0.030
FRISK 0.041 0.092 0.100 0.065 1.000 0.051 0.003 0.118 0.088 0.100 0.045 0.014 0.002
FSIZE 0.198 0.150 0.131 0.135 0.051 1.000 0.028 0.169 0.172 0.058 0.585 0.192 0.026
GDP 0.029 0.002 0.007 0.001 0.003 0.028 1.000 0.000 0.000 0.017 0.028 0.002 0.037
INDUSTRY 0.142 0.167 0.155 0.153 0.118 0.169 0.000 1.000 0.144 0.003 0.169 0.074 0.018
INSOWN 0.024 0.580 0.568 0.319 0.088 0.172 0.000 0.144 1.000 0.386 0.196 0.030 0.078
IODIR 0.028 0.373 0.352 0.013 0.100 0.058 0.017 0.003 0.386 1.000 0.064 0.021 0.041
LSIZE 0.693 0.174 0.152 0.060 0.045 0.585 0.028 0.169 0.196 0.064 1.000 0.157 0.019
MCAP 0.314 0.033 0.013 0.009 0.014 0.192 0.002 0.074 0.030 0.021 0.157 1.000 0.003
ROE 0.053 0.080 0.075 0.030 0.002 0.026 0.037 0.018 0.078 0.041 0.019 0.003 1.000
Notes: This table recapitulates the estimated coefficients of correlation among all indicators. We utilize annually data for Saudi firms
during the period of study through 2009 to 2018
Source: Own Elaboration

PAGE 66 j JOURNAL OF INVESTMENT COMPLIANCE j VOL. 22 NO. 1 2021

 Table 5 Unit root test
Levin, Lin and Chu test test statistic
Variables t-statistic p-value

ACOST 11.61 0.0000

BSIZE 10.80 0.0000
BLOCK 8.06 0.0000
DFIN DFIN is a dummy variable, so we consider it
stationary.
FRISK 8.60 0.0000
FSIZE 8.09 0.0000
GDP 11.31 0.0000
INDUSTRY 10.67 0.0000
INSOWN 10.77 0.0000
IODIR 9.80 0.0000
LSIZE 10.97 0.0000
MCAP 10.21 0.0000
ROE 9.32 0.0000
Notes: This table recapitulates the results of stationary test. In this test the calculate p-value is
compared to 10%. If the calculate p-value <10% therefore, we refuse the hypothesis H0 and if the
calculate p-value > 10% then we accept the hypothesis H0. With the hypothesis H0: all variables are
non-stationary. Statistical meaning at 1% is presented by ( )
Source: Own Elaboration

variables are stationary in level based on the unit root test. So, all the variables are not
integrated, and we can use linear regression in our study.

5. Empirical results
5.1 Var estimation
After having stationary series, we will construct VAR (Vector Auto Regressive) models.
These models permit, on the one hand to examine the impacts of one variable on the other
through random surprise simulations and on the other hand to perform an assessment in
terms of causality. In the case of a VAR process, each of the series is developed
corresponding to its own delays and the delays of the other series.
To establish the optimum delay number for the VAR demonstration, we will estimate
numerous models for an order varying from 1 to h (h being the maximum delay allowable by
economic theory or by the available data).
The delay P, which will diminish the criteria LR (sequential modified LR test statistic (each
test at 5% level)), FPE (Final prediction error), AIC (Akaike information criterion), SC
(Schwarz information criterion) and HQ (Hannan-Quinn information criterion), will be
maintained. According to the criteria employed in Table 6, we note that the optimum
number of delays is equal to 2 for the models to be estimated. In this case, we will estimate
a VAR model with order 2.
We utilize a VAR model with order 2 to examine the influence of agency conflicts among
managers and shareholders on corporate risk management and financial performance of
Saudi firms listed in the Saudi Stock Exchange Tadawul through the period of study from
2009 to 2018. Table 8 recapitulates the estimation of the VAR model. From this Table, we
show that the coefficients of determination for the two estimate models are greater than 0.6,
hence, the two estimates are characterized by a good linear fit.
Also, we employ the test of normality of residues. Certainly, if residues are distributed
normally then we can admit that they are distributed identically and independently. From the
Table 7, the probabilities of (skewness, kurtosis and Jarque-Bera) are less than 5% then the
residuals are normally distributed and do not have a problem of heteroscedasticity.

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 Table 6 VAR Lag order selection criteria test
Lag LogL LR FPE AIC SC HQ

0 100.54485 40.21794 100544.85 13.40598 12.568106 14.528730

1 90.9863 36.39452 90986.3 12.131507 11.37328 13.147520
     
2 78.51575 31.4063 78515.75 10.468767 9.814468 11.345525
3 86.3711 34.54844 86371.1 11.516147 10.79638 12.480623
4 81.001 32.4004 81001 10.800133 10.125125 11.704644
5 80.3427 32.13708 80342.7 10.71236 10.04283 11.609520
Notes:  Indicates lag order selected by the criterion, LR: sequential modified LR test statistic (each
test at 5% level), FPE: Final prediction error, AIC: Akaike information criterion, SC: Schwarz
information criterion, HQ: Hannan-Quinn information criterion
Source: Own Elaboration

Table 7 VAR Residual normality test

Component Skewness Chi-sq df Prob.

1 16.17322 62777.52 1 0.0000

2 26.31592 166206.7 1 0.0000
Joint 228984.2 2 0.0000
Component Kurtosis Chi-sq df Prob.
1 598.4472 21273446 1 0.0000
2 929.7551 51532498 1 0.0000
Joint 72805944 2 0.0000
Component Jarque-Bera df Prob.
1 21336223 2 0.0000
2 51698705 2 0.0000
Joint 73034928 4 0.0000
Notes: This table recapitulates the results of VAR residual Normality test. The probability are less than 5%
then the residuals are normally distribution and we have in the absence of a problem heteroscedasticity
Source: Own Elaboration

For the estimation of the variable FRISK which measures the corporate risk management of
each firm, we remark that there are 8 significant variables, but with different signs.
We find that the variable FRISK on date (t-1), which measures corporate risk management of
Saudi firms, has a positive impact on risk management on date t at a threshold of 1%. So, if
corporate risk management on date (t-1) increases by 1 unit, then, the corporate risk management
on date t increases by 1.271362 units. This result indicates that the level of risk of the previous year
can increase the risk level of this year, so the firm can maintain its exposure to this risk.
However, the variable FRISK on date (t-2), which measures corporate risk management of
Saudi firms, has a negative effect on risk management on date t at a threshold of 1%. So, if
corporate risk management on date (t-1) increases by 1 unit, then, the corporate risk
management on date t decreases by 0.265023 units, which explain the role of the board in
risk management and exposure.
The variable ACOSTS, which refers to agency cost proxies, has a positive impact on
corporate risk management of Saudi firms. So, the agency conflicts among managers and
shareholders can increases corporate risk management in the case of Saudi firms.
Also, we found that the variable BSIZE, which measures the number of directors on the
board, has a negative impact on corporate risk management. This result indicates how the
various decisions issued by various directors can negatively affect the corporate risk
management of Saudi enterprises.
The variable DFIN, which reflects that the firm is a financial institution, has a positive impact
on corporate risk management of Saudi firms. Then, the firms that are more successful are

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 Table 8 Vector autoregressive estimates
FRISK ROE

FRISK(1) 1.271362 45.42540

[ 50.6559] [5.06805]
FRISK(2) 0.265023 68.31532
[10.3676] [0.10048]
ROE(1) 1.73E-08 0.247530
[ 0.01771] [ 9.50087]
ROE(2) 1.58E-08 0.062742
[0.01609] [ 2.39721]
C 0.006377 28.09618
[2.50143] [ 0.41435]
ACOST 4.31E-08 0.006400
[5.13928] [0.77763]
BSIZE 6.18E-07 0.096292
[9.10552] [0.61813]
BLOCK 9.10E-06 0.901620
[0.09733] [ 2.36275]
DFIN 3.22E-06 0.217018
[4.45502] [7.15302]
FSIZE 7.65E-06 1.228143
[8.02037] [0.12289]
GDP 6.51E-07 0.032045
[ 0.82692] [1.53000]
INDUSTRY 1.76E-05 0.791641
[ 3.53225] [ 0.89995]
INSOWN 2.77E-07 0.075591
[0.06386] [ 0.65557]
IODIR 9.14E-07 0.052349
[ 0.12579] [4.27099]
LSIZE 1.46E-06 0.201198
[ 0.03625] [ 2.18744]
MCAP 1.16E-09 0.005679
[0.00504] [ 0.92530]
R-squared 0.995011 0.102598
Adj. R-squared 0.994954 0.092507
Notes: This table recapitulates the estimated coefficients from VAR model. To examine empirically
this model, we utilize annually data for Saudi firms throughout the period starting 2009 to 2018.
Statistical significance at 1%, 5%, and 10% level are presented by ( ), ( ), and ( ), respectively.
Values between [] indicate t-statistics
Source: Own Elaboration

those that see risk management as a cornerstone. To ignore it is to run to almost certain ruin
or to seriously limit its capital gains.
The variable FSIZE, which measures the natural log of annual sales for each firm, has a
positive and significant impact on the corporate risk management of Saudi companies
during the period of study. This finding implies that the increase in the annual sales of a firm
encourages its responsibility to manage its risk level relative to its activities. Then, the
variable INDUSTRY, which indicates the industry classifications of Saudi firms (17 industry
classifications), has a positive impact on corporate risk management. This result shows that
each industry classification has a specific risk that the firms needs to manage, such as
financial, economic, natural, political, social, [. . .], etc.).
For the estimation of the variable ROE, which measures the financial performance of Saudi
firms listed in the Saudi Stock Exchange Tadawul through the period of study from 2009 to
2018, we find that there are 7 significant variables, but with different signs.
We show that the variable FRISK on date (t-1), which measures corporate risk management
of Saudi firms, has a negative effect on financial performance on date t at a threshold of 1%.

VOL. 22 NO. 1 2021 j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 69

 So, if corporate risk management on date (t-1) increases by 1 unit, then, the financial
performance on date t decreases by 45.42540 units. This result indicates that the level of
risk of the last year can decrease the financial performance of the current year, so the firm
can maintain its risk exposure to increase its performance.
However, the variable ROE on date (t-1) and (t-2), which measures the financial performance
of Saudi firms, has a positive effect on performance on date t at a threshold of 1%. So, if the
financial performance on date (t-1) and (t-2) increases, then, the financial performance on
date t increases again which explains the importance of past years’ results and their impact
on future-year results. Also, this result confirms the continuity of good performance in Saudi
firms and the importance of their strategies to manage and to regulate their activities.
In addition, the variable BLOCK, which indicates the percentage of ordinary shares held by
shareholders who own 5% or more of these shares, has a positive impact on the financial
performance of Saudi firms listed in the Saudi Stock Exchange Tadawul at a threshold of
5%. This result shows that if the percentage of ordinary shares held by shareholders who
own 5% or more of these shares raises by 5 units, so the financial performance of Saudi
firms increases by 0.901620 units.
The variable DFIN, which reflects that the firm is a financial institution, has a negative impact on
financial performance of Saudi firms. Then, the firms that are more successful are those that see
financial performance as a normal objective. The variable IDIOR, which measures the ratio of
the number of independent outside directors to the total number of directors on the board, has a
negative impact on financial performance of Saudi firms. This finding shows the importance of
conflict of interest between the internal and the external directors in the Saudi firms.
Also, the variable LSIZE, which measures the natural log of total assets, is statistically
significant and positive. The size of the Saudi firms affects their performances expressed by
the variable ROA. Thus, the impact of size on the profitability of banks is relevant, in that an
optimal level of banking assets affects the maximum level of profitability.
By analyzing our empirical findings, we can conclude that the agency conflicts among
managers and shareholders affect corporate risk management and financial performance
of Saudi firms listed in the Saudi Stock Exchange Tadawul through the period of study from
2009 to 2018. This impact is observed by increasing the risk level (decreasing the corporate
risk management) and decreasing the financial performance of Saudi firms.
Also, we can conclude that all the indicators used relative to the board and ownership
composition have the same impact on the corporate risk management and financial
performance of Saudi firms. These findings imply that the risk and the performance of Saudi
forms are correlated significatively to board and ownership composition, which can be
explained by the governance mechanisms adopted by the Saudi companies.

5.2 GLM estimation

In this part, we utilize the Generalized Linear Model (GLM) to confirm the results obtained
by the VAR estimation. Also, we use the GLM to confirm the robustness of the VAR
estimation. Additionally, the Generalized Linear Models are employed to study how a
continuous variable depends on one or more predictors.
The empirical findings showed in Table 9 and Table 10 corroborate and confirm the results
obtained by the VAR model. Then, we find some important conclusions such as:

䊏 The separation between control and ownership creates agency conflicts between
managers and shareholders, which can influence their behavior in decision-making
and performance of their firms. The agency problem exists when the principal and the
agent choose different actions because of their diverging risk preferences (Jensen and
Meckling, 1976).

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 Table 9 Generalized linear model estimates for FRISK variable
Variable Coefficient Std. Error z-Statistic Prob.

ACOST 0.000202 2.54E-06 79.41367 0.0000

BSIZE 0.000228 0.000131 1.738025 0.0822
BLOCK 0.000187 0.002005 0.093274 0.9257
DFIN 0.001406 0.000149 9.454873 0.0000
FSIZE 0.258885 0.000302 857.4188 0.0000
GDP 5.24E-06 1.59E-05 0.329090 0.7421
INDUSTRY 0.001851 0.000721 2.566398 0.0103
INSOWN 1.87E-05 0.000101 0.186341 0.8522
IODIR 7.43E-05 0.000155 0.478176 0.6325
LSIZE 0.027439 0.000104 263.5191 0.0000
MCAP 1.32E-05 5.19E-06 2.552082 0.0107
Notes: This table recapitulates the estimated coefficients from GLM model. To examine empirically
this model, we utilize annually data for Saudi firms throughout the period starting 2009 to 2018.
Statistical significance at 1%, 5%, and 10% level are presented by ( ), ( ), and ( ), respectively
Source: Own Elaboration

Table 10 Generalized linear model estimates for ROE variable

Variable Coefficient Std. Error z-Statistic Prob.

ACOST 0.005847 0.002611 2.239249 0.0251

BSIZE 0.127710 0.134806 0.947359 0.3435
BLOCK 0.802516 2.061641 0.389261 0.6971
DFIN 0.225324 0.152884 5.473823 0.0000
FSIZE 0.155677 0.310430 0.501486 0.6160
GDP 0.026065 0.016365 1.592692 0.1112
INDUSTRY 0.955857 0.741351 4.289345 0.0000
INSOWN 0.083397 0.103331 0.807081 0.4196
IODIR 0.040688 0.159661 0.254841 0.7988
LSIZE 0.073251 0.107056 6.684228 0.0000
MCAP 0.005871 0.005334 1.100763 0.2710
Notes: This table recapitulates the estimated coefficients from GLM model. To examine empirically
this model, we utilize annually data for Saudi firms throughout the period starting 2009 to 2018.
Statistical significance at 1%, 5%, and 10% level are presented by ( ), ( ), and ( ), respectively
Source: Own Elaboration

䊏 Managers are more cautious about risk since they cannot diversify their human capital,
while shareholders can diversify their portfolio (Fama, 1980).
䊏 Conflicts of interest arise from the differences between the work horizon, the risk
assumed, the profitability of enterprises, and the level of remuneration desired by the
managers and shareholders (Byrd et al., 1998).
䊏 Our empirical results have shown that shareholder-controllers, in view of their power over the
management of the company, can appropriate profits at the expense of small shareholders,
through off-market transactions with controlled entities (Harada and Nguyen, 2011).

6. Conclusion
This research aims to better understand the relationship between ownership structure on
the one hand and risk management and performance in the Saudi context. More
specifically, we have examined the effect of the structure of ownership (concentration of
capital and managerial ownership, in other words, agency conflicts between directors and
shareholders) on risk management and financial performance, measured by return on
investment. equity/return on assets, for a population of 180 Saudi companies listed on the
Saudi Stock Exchange Tadawul during the period from 2009 to 2018.

VOL. 22 NO. 1 2021 j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 71

 Based on the analysis of the regressions developed, the results of the impact of agency
conflicts between managers and shareholders on risk management and on the financial
performance of Saudi companies are as follows:
䊏 First, there is a positive relationship between concentration of capital and managerial
ownership and risk management and a negative relationship between concentration of
capital and managerial ownership and financial performance, measured by the ROE
ratio. Therefore, the holding of capital by managers constitutes an endogenous
response to the process of maximizing profit and managing corporate risks.
䊏 Second, we demonstrate that the separation between control and ownership
establishes agency conflicts among managers and shareholders that can affect their
behavior in decision-making and the performance of their firms.
Also, we find that managers are more careful about risk since they cannot diversify their
human capital, while shareholders can differentiate their portfolios.
Finally, we conclude that shareholder-controllers, in view of their power over the
management of the firm, can appropriate profits at the expense of small shareholders,
through off-market transactions with controlled entities.
Also, Saudi companies must deepen the study of agency costs linked to a shareholding
structure through the analysis of monitoring, obligation, and opportunity costs. They should
use a non-linear model to study the relationship between shareholder structure on the one
hand and risk management and financial performance on the other.

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Corresponding author
Lamia Jamel can be contacted at: lajamel@yahoo.fr

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