A Reaction Paper on Corporate Governance

Lim, Christine Diane

De La Salle University

The Need for Corporate Governance

Corporate Governance has been vital in the success of both private investments and public corporations.
It is a system by which companies are directed and controlled by the relationship between its directors,
shareholders, customers, suppliers, and other stakeholders. In the agency theory discussed, agents and
managers perform function on behalf of shareholders. However, agents or managers have the tendency
to prioritize profit ahead of shareholder value since manager compensation is tied to managerial
performance. Thus, corporate governance should be in place to avoid this conflict of interest which are
primarily overseen by a board of directors. Board of director’s main functions are to monitor and manage
actions in advising the CEO and securing external resources or audits vital to build corporate capabilities
increasing board governance, transparency and disclosure, and most importantly to protect minority
shareholders. The main objective is to balance the interests of many stakeholders such that the creation
of action plans, business regulations, structures, and internal controls attain optimum corporate
performance. The clear implication for corporate governance from an agency theory perspective is that
“adequate monitoring or control mechanisms need to be established to protect shareholders from
management’s conflict of interest” (Latham, 2010)

The Australian Studies

Most companies strive to have high level of corporate governance and it is not just a measure of profit;
companies need to demonstrate good corporate citizenship through environmental awareness, ethical
behaviour and sound governance practice to avoid pressing issues such as Enron and WorldCom. In
order to address this, corporate governance (and performance) is heavily influenced by the composition
of its board. The article on “Corporate Governance: International Review” suggests that board size is
correlated with firm value. There is a positive relationship between the proportion of inside directors and
the market based measure of firm performance. With respect to board composition, agency theory
suggests that a greater proportion of outside directors will be able to monitor any self-interested actions
by managers. The methodology used to prove this was to use a large scale investigations on the
Australian corporate governance environment. A collection of 348 companies trading in the Australian
Stock Exchange Limited was used. It was 500 prior, however the study removed head offices not within
Australia and whose majority sales were outside Australia. Banks were also excluded due to most of its
assets are loans, as well as mining companies who also had abstract assets and separate population of
firms. The variables used are company size, board composition, number of interlocks of its directors,
while corporate performance measure used is the company’s Return on Assets (ROA). The study
concluded that the board composition was relative small in average of 6.6 directors ranging from 2-19.
Most of the companies had outside directors, only having 6 companies to have fully internal boards. 35
had fully external boards while larger boards in proportion with outside directors. Interlocks are also
positively correlated with assets, revenue, and market capitalization. A great number of interlocks was
applicable to larger boards and more diverse companies. Larger board size is associated with a separate
chairman and CEO, as well as relationships with greater proportion of outside directors. Better
performance is related to insider directors, CEO duality and number of interlocks. (Kiel & Nicholson, 2003)

Board Size, Composition and Interlocks on Corporate Performance

There are very distinct relationships between company size and composition such that larger companies
have larger boards and more interlocked directors. This ensures proportional, equitable basis,
transparency and disclosure of relevant information that are open to discussions, free of bias. Another
research that supports the Australian study was the Pakistan study using the Karachi Stock Exchange.
Similar to the Australian study, the variables used were 500 non-financial companies selected based on
their market capitalization. The variables used were board size, and composition including interlocks
(board independence and audit committee independence) Empirical findings include that Pakistan boards
and audit committees are more effective with board diversity as this type of composition protects the firms
from value destroying strategies which in effect, helps the firms to improve shareholder value. (Azeem,
Hassan, & R., 2013)

However, critiques also state that boardroom diversity does not always raise firm value. Some critique
suggests inconsistent results related to boardroom diversity and firm performance relationship. The
article entitled “Corporate Governance on National Institutions” suggest that cross national comparisons
of board influence on corporate governance is dependent not on size and composition but with the
differences in the legal system and institutional characteristics in a specific country. For example, the
agency conflict takes on very different forms across countries not only due to the different patterns of
shareholder concentration but based on the different social identities of block holders such as families,
the state, banks, foundations, or business groups. (Filatochev, Jackson, & Nakajima, 2013) Furthermore,
as cited from El Mehdi, there is an upper limit to boards which is eight directors ideally. More than eight
would result to more conflict in group dynamics and board performance. This was illustrated in a study of
listed firms in Turkey, with stock performance declining for companies with larger boards. (Kabigting,
2011)

Corporate Governance in the Philippines

In the Philippines, it is also believed that corporate governance has significant relationship between its
independent board of directors, board size and its corporate performance including return of assets
(ROA), return on equity (ROE), and earnings per share (EPS). Attempts to analyse relationships between
corporate governance and the board compositions vary depending on the selected companies. For
instance the corporate governance among banks listed in the Philippine Stock Exchange resulted to
family controlled firms having higher profitability than that of interlocks (Kabigting, 2011) Another study
was with the selection of publicly listed property companies in the Philippines. The finding of this study
suggests that only managerial ownership significantly influence the firm performance of publicly listed
property companies in the Philippines. Increased ownership is a result of dynamism in the corporate
environment where the board is likely to support actions that will benefit them since they are both owners
and executives of the firm. (Ferrer & Banderlipe, 2012)

In conclusion, corporate governance is a major pillar in the business environment. Good corporate
governance should be rightfully seen in regulators and industry leaders. Corporate governance is needed
to make corporate management more accountable, and their auditors more rigorous. Good governance
requires fair legal frameworks that should be enforced impartially. Board size may manifest a significant
positive relationship with shared prices however, we should also consider that corporate governance is
not just correlated with board size but also in the environment, characteristics, and type of industry where
the board operates or leads.

Bibliography

Azeem, M., Hassan, M., & R., K. (2013). Impact of Quality Corporate Governance on Firm Performance:
A Ten Year Perspective . Pakistan Journal of Commerce and Social Sciences, Vol 7 (3): 656-670.

Ferrer, R., & Banderlipe, R. (2012). The Influence of Corporate Board Characteristics on Firm
Performance of Publicly Listed Property Companies in the Philippines. Academy of Accountign
and Financial Studies Journal, Vol (16): 123-137.

Filatochev, I., Jackson, G., & Nakajima, C. (2013). Corporate Governance and National Institutions: A
Review and Emerging Research Agenda. Asia Pacific Journal of Management .

Kabigting, L. (2011). Corporate Governance Among Banks Listed in the Phililppine Stock Exchange.
Journal of International Business Research, Vol (10): 59-67.

Kiel, G., & Nicholson, G. (2003). Board Composition and Corporate Performance: How The Australian
Experience Informs Contrasting Theories of Corporate Governance. Board Composition and
Corporate Performance, Vol 11(3): 189-205.

Latham, M. (2010). The Corporate Monitoring Firm. Journal of Finance and Banking.