Accounting
Dissertation – Board Structure and Company Performance (Part 1 of 5)

CHAPTER 1: INTRODUCTION

1.1 Research Background

In the recent years, the corporate scandals are becoming widespread negative events affecting investors and public in many of the countries around the world. Unfortunately, not only the frequency of occurrence of corporate scandals has not reduced, but the magnitude of the harms bring forward by these corporate scandals are becoming more serious in the recent years (Brewer, 2007). Consistent with such trends, there are greater concerns by the public as well as the regulatory bodies on better and more effective corporate governance to be implemented in public listed companies in the recent years. One aspects of effective corporate governance is about having more independent non-executive directors in the board structure (Aggarwal et. al., 2010). In the context of good corporate governance, independent directors are supposed to be the independent third party to safeguard shareholders interests and company assets. Independent third party ‘watchdog is often essential because’ the key executives in a company may not motivated to act in the best interests of the business owners, as they may have their personal agenda to push forward in the corporate scene (Hong-xia et. al., 2008). For example, it may be possible for the manager to engage in more risky venture to profit from the stock options granted to them, or to invest heavily on their personal pet projects (which might not be wealth maximizing projects for shareholders), or to the extent of heavily involving in fraud or misappropriation of company assets for selfish personal benefits (Brigham et. al., 2004). Without the help of independent third party director in a particular company, shareholders rights and interests may not be taken care properly or neglected by unethical or irresponsible key executives in a company. Thus, the importance of independent directors in ensuring effective corporate governance is simply undeniable.

Yet, from another perspective, the importance of independent directors to safeguard stakeholders’ interests is also another frequently argued proposition nowadays. As argued by Spitzeck and Hansen (2010), management should not only take care of the interests of shareholders only, but should take into account the interests and rights of various stakeholders in their decision making process. Accordingly, the various stakeholders should include the employees, customers, suppliers, intermediaries, competitors, government, public, communities and the society as a whole (Greenwood et. al., 2010). In a similar vein, Enderle (2010) supported such view, asserting that corporations today should be more proactive in exhibiting and adopting Corporate Social Responsibility in the management decision making process. In light of these discussions, the roles of independent directors should be extended towards taking care of the interests of various stakeholders, to ensure ethical decision making by executives, for a more ethical, sustainable and responsible business growth of a particular organization in the increasingly competitive business environment.

In the context of Corporate Social Responsibility, shareholders interests, business ethics and independent directors, one of the frequent and perhaps, controversial topic being debated and studied by scholars are the linkages between adoption of good and ethical business practices towards corporate performance. For example, there are studies if adoption of Corporate Social Responsibilities will really enhance corporate performance in the competitive business landscape. Among such studies include research from Scholtens (2006), as well as study conducted by Bihari and Pradhan (2011). Then, there are also studies if good corporate governance will reduce the risk faced by corporations and indeed will enhance financial profitability of the particular firm with good corporate governance. For example, Cartwright and Craig (2006) argued that good corporate governance system will likely able to ensure more sustainable profitability for a corporation, and having good corporate governance system can be an essential part of strategic management of a firm. Then, Balkau and Sonnemann (201) argued that corporate governance is crucial to mitigate risks arise from the dynamic and complexities of value chain, and is likely to enhance sustainability of corporate performance in the fast changing business environment. Then, there are also studies concerning if the existence of independent directors will likely able to enhance corporate governance system in a corporation, and subsequently will enable better corporate performance in the fast changing business economy. As will be articulated and discussed in greater depth in Literature Review section in this dissertation, some of the scholarly studies on this topic include those performed by Liona et. al., (2007), Abdullah (2006), Lara et. al. (2007), Benkraiem (2009), and McCabe and Nowak (2008). Overall, it can be observed that most of the studies able to discover certain degree of linkages or empirical evidences that adoption of Corporate Social responsibilities, good corporate governance, and existence of higher proportion of independent directors in board structure are likely to enhance company performance, be it financially or non-financially.

However, it can be seen that the studies on relationships between adoption of Corporate Social Responsibilities, good corporate governance, and existence of higher proportion of independent directors in board structure to corporate performance is not conclusive. Most of the studies are performed by scholars to investigate the situations in the more developed or famous countries. The studies on emerging countries or smaller nations are relatively lesser. As such, there is a knowledge gap in this area, if the adoption of good business ethics and strong corporate governance structure is likely to contribute to better corporate performance in the smaller emerging countries. Specifically, there are lesser evidences that indicate that existence of positive relationships between adoption of good business ethics and strong corporate governance structure to corporate performance is a phenomenon across countries, culture and business environment.

To conduct comprehensive studies on the relationships between ethical business practices and strong corporate governance structure across nation can be a daunting and resources consuming task. As there are too many possible viable research areas and knowledge gaps uncovered by the previous literatures, there are many unanswered questions on the linkages between ethical business practices and effectiveness of corporate governance structure to various corporate dimensions. It will be good to have a comprehensive study on the impacts of ethical business practices and effectiveness of corporate governance structure to various corporate dimensions, but that is simply impossible, considering the limited time and resources available to conduct such study in this dissertation. As such, this dissertation will zoom down into the issue of board structure to corporate performance in Malaysia. Specifically, in this research, the board structure, as will be investigated form the proportion of independent non-executive directors in the board structure, to the company financial performances will be analyzed and studies. In the next section, the research rationales will be articulated in greater details.

1.2 Rationales of the Research

The issues concerning corporate governance and ethical business practices are obviously something increasingly being paid attention by business and society today. In an increasingly competitive and greed-driven economy, to act with ethical conscience and to have good system governing human behaviors are something too important not to be ignored. In the context of business ethics and corporate governance, among the common issues relevant to the society today include the issues of Corporate Social Responsibility, Corporate Governance, business ethics and roles of independent directors in corporations. As discussed before, the constantly recurring corporate scandals and frauds within corporations in competitive business landscape today are demanding something to be changed and implemented to prevent such negative phenomenon from repeating continuously in the future (Brewer, 2007). As such, it is indeed largely observed that studies on these areas have been increasing in the recent years.

In this dissertation, the study of board structure to corporate performance is selected because such issue can be approach from a quantitative study. The nature of quantitative study will enable the research findings to be more objective and less subjected to biased interpretation from the researchers. For example, the board structure can be easily stated as a percentage of independent directors in the board. Then, the financial performance of a company can be approach from several financial metrics, such as Return on Equity (ROE), growth of net income, and stock returns over several years under the research period. Apart from that, it is observed that such kind of study is relatively lesser, if compared to the other types of studies to investigate ethical business practices and effectiveness of corporate governance structure to various corporate dimensions. Thus, it is perceived that a study of such kind is crucial as these studies will add value to the existing literature.

Indeed, as discussed in the previous section, there are actually some literatures regarding board structure and its impacts to company performance. Specifically, there are some studies available in investigating the amount of independent non-executive directors to company performances in several developed countries. Some of such studies include: Liona et. al., (2007), Abdullah (2006), Lara et. al. (2007), Benkraiem (2009), McCabe and Nowak (2008), and Hamill et. al. (2006). However, there are relatively few studies of such nature that studies the relationships of board structure (as proxy by independent non-executive directors) to company performances in emerging countries. Thus, in this study, Malaysia will be used as a case study to understand if such relationship hold true in emerging countries such as in Malaysia. The study to be conducted will be useful to further investigate if the existence of positive relationships between adoption of good business ethics and strong corporate governance structure to corporate performance is a phenomenon across countries, culture and business environment.

Apart from that, by having better understanding on the board structure to company performance can have several implications to investors as well as management. Firstly, if statistically significant relationships are found, investors can then include the board structure as screening criteria in their stock selection process. It is then possible for them to bet on stock or companies that have better corporate governance structure, with a high expected company performance in the future. Secondly, the managing directors can also rely on such information, and to hire more independent non-executive directors to serve in the company board. Not only are that, should such study able to elicit reliable empirical evidences that effective corporate governance structure, as characterized by higher proportion of independent non-executive directors in the board structure, able to enhance the profitability of a particular company, and hence the correspond stock returns, more supporting evidences encouraging socially responsible investing can be provided. Overall, that will be powerful to encourage investors to fund those business with better governance structure, and in the long run, such awareness among investors will likely pressure executives to strive for better corporate governance structure and adoption of ethical business practices and behaviors among the management of respective company in the future.

1.3 Research Objectives

Following the arguments as presented above, several research objectives can be formulated. Firstly, the study presented in this dissertation is structured to investigate the relationships between the board structures to the company financial performance companies in Malaysia. The financial performance of a particular company will be investigated from three perspectives as follow: (a) average Return on Equity (ROE) figure of the respective company for the past five years; (b) average growth of Earning per Share (EPS) of the respective company for the past five years; and (c) the stock return of the respective company for the past five years. As such, three research objectives can be more precisely stated as follow.

 

Research Objective 1 : To investigate if there exists positive correlation relationships between proportions of independent non-executives directors in board structure to the average Return on Equity (ROE) figures of companies listed in Malaysia, for research period from year 2006 to 2011.
Research Objective 2 : To investigate if there exists positive correlation relationships between proportions of independent non-executives directors in board structure to the average growth of Earning per Share (EPS) of companies listed in Malaysia, for research period from year 2006 to 2011.
Research Objective 3 : To investigate if there exists positive correlation relationships between proportions of independent non-executives directors in board structure to the average stock returns of companies listed in Malaysia, for research period from year 2006 to 2011.

 

Then, from those findings, constructive suggestions, dependent on the research findings, can be provided to both management and investors if having higher proportions of independent non-executive directors in the board structure can contribute to company performances.

 

Research Objective 4 : To suggests several strategies and implications from the research for applications in real corporate world.

 

1.4 Structure of this Dissertation

This dissertation is arranged as follow. Firstly, the research background, rationales for research, and the respective research objectives are outlined in this chapter. Then, in Chapter 2, a comprehensive literature review on the topic of independent non-executive directors will be presented. In Chapter 2, roles, duties and responsibilities of independent directors will be outlined. Then, the importance of independent directors to enhancing company performance while at the similar time, risk mitigation of a particular company will be articulated. Previous studies related to relationships between independent directors to corporate performance from different dimensions will be discussed. The limited literature available concerning issues of independent directors in the Malaysian context will also be provided. Apart from that, empirical evidences on positive relationships between proportions of independent directors to corporate performance in other countries performed by scholars in the past will also be presented. After that, the research methodologies adopted and employed in the study conducted in this dissertation will be presented in Chapter 3. The sources of data, the specific assumptions, and the procedures and formulas used in conducting this study will be outlined in this particular chapter. Next, in Chapter 4, result findings from this study will be articulated. Specifically, data output generated from SPSS will be presented and analyzed in this chapter. Lastly, in Chapter 5, conclusions from the research findings will be summarized and articulated. The implications from this research will also be outlined. Later, suggestions for further research in the future will be presented.

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