The Impact of Corporate Financial Performance on Market Value - Essay Example

The impact of Corporate Financial Performance on Market Value mediating by Corporate Governance and Sustainability Report An Empirical Study on the reality of the commercial banks operating in Indonesia ChapterI Introduction 1.1 Back ground of the study Growing individual awareness of environmental, social, and ethical issues is strongly affecting purchase decisions of market participants. This development is fueling private and institutional investment decisions towards socially responsible investing, also labeled ethical or sustainable investing (Renneboog, Terhorst, & Zhang, 2008). This investment strategy consists of choosing stocks on the basis of environmental, social, and ethical screens (Barnett & Salomon, 2006). There are changes in society, the thinking and behavior of people is changing, business environment is changing, with new trends and concepts being developed to which corporates should react if they want to be successful. The process of internationalization, changes the possibility of creating higher values for the stakeholders (M. Tóth, 2012). In a global business environment, we see different opinions calling for change of approaches to corporate governance and to control and manage companies in a way that will continue to achieve both effective performance and appropriate social accountability and responsibility(B.Tricker, 2009). The construct of firm performance is of central importance to management research because explaining variation in performance is an enduring theme in the study of organizations (e.g., Hoopes et al., 2003). Although firm performance has been recently proposed as a multidimensional construct that consists of many different aspects such as operational effectiveness, corporate reputation, and organizational survival (Richard et al., 2009), one of the most extensively studied areas is its financial component, the fulfillment of the economic goals of the firm (Barney, 2002; Venkatraman and Ramanujam, 1986). To assess the financial aspect of firm performance (i.e., financial performance), organizational researchers generally use either accounting-based measures of profitability such as return on assets (ROA), return on sales (ROS), and return on equity (ROE), or stock market-based measures such as Tobins Q and market return (Combs et al., 2005; Hoskisson et al., 1999; Hult et al., 2008). When the company grows as a result of a financial decision such as detention of profits, then that growth will be reflected on the current value of the shares on the grounds that it is the result of a reflection of what will happen in the future. The present value of the shares is the sum of the future cash flows, and this will be reflected on the accounting profits when they occur and they won’t reflect the historical accounting profits(Altahtamouni& Alslehat, 2014). There is more to corporate performance than what traditional financial reporting canillustrate(Bassen& Kovacs, 2008). The increasing breach between financial reporting and firm value results from the declining ability of accounting and financial reporting data to represent and report information that is useful in assessing firm value (Yen, 2004). The shift of western countries to information and service economies has drastically reduced the importance of tangible assets within enterprises. Accordingly, intangibles increasingly account for a significant proportion of the value of acompany, especially over the longer term. The efficient market theory states that share prices reflect all known information relating to a share. All new information has the potential to impact the fundamental valuation of equity. The more complete and reliable the information available, the more accurate is the valuation of the future performance of the respective security. Even if extra-financial information may not necessarily affect the price of a firm’s share during normal operations, in cases where reputational or monetarily quantifiable litigation risk exists, investment professionals turn much attention to the respective information(Bassen& Kovacs, 2008). Presently, business operations face a variety of changes both internal and external problems. Therefore, it makes more cooperation among industries, government and non-governmental organizations to avoid the problems of no accountability, as well as, they are interested in emerging ways to share responsibility, and lawfulness in order to protect the environment and natural resources (Christofi, et al., 2012), The mechanism was proposed which comprised of 4 factors (1) corporate governance which is one of the mechanism that is an important part in the process of the business to be structuring and control the operations of the business to be more productive. Moreover, its performance can generate returns and wealth for the shareholders and stakeholders. Businesses have responsibilities to act with transparency, (2) sustainable development reporting reflects the current state of affairs for the firms stakeholders to use the information to regulators to evaluate the performance of the firm and analyzes the rise of social, environmental factors (KPMG, 2013). However, the reporting responsibilities of companies in each country are also a voluntary manner. For the case of Thailand, it was rated at 16 out of 20 countries which listed companies disclosed in their annual report were not transparent, and do not adequately reflect the reality on the international financial analysis. (CIFAR, 1995), (3) The results of operations of the firm have to focus on the best interests of shareholders and on the wealth to the corporate sustainability, and (4) financial reporting standards are important in order to ensure the practice of accounting and establish the accuracy of the books of accounts of companies to the same standard and recognition of the financial statements to the general public. The great point is that what information a firm should report and how companies should report. The most important is the firm should procedure the best process and has to report and pose the greatest value to its shareholders and stakeholders (KPMG, 2013). Morover, Corporate governance is defined by OECD (2004) as the procuders and the process accourding to which 
an organization is directed and controlled. Hence the corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organization such as the board of directors, managers, shareholders and other stakeholders and lays down the rules and procedures for decision-making. The increasing interest dedicated to corporate governance can be explained in light of the recent financial scandals like Enron, Worldcom, Cirio. Both investors and shareholders are interested in corporate governance, the former in order to invest with greater awareness and fewer risks, the latter in order to exploit the positive effects of a good governance on the firm value. Several studies (Gompers et al., 2003; Drogbetz et al., 2004; Beiner et al., 2006) prove the existence of a positive relationship between corporate governance and firm value. Anderson and Gupta (2009) and Tricker (2012) found that various research scholars defined corporate governance dimensions in different manner. For example, some research scholars perceived good corporate governance as transparent disclosures of financial results of the firm while other research scholars perceived good corporate governance as equal distribution of control rights between the firm and its shareholders. Historically, corporate governance norms are being summarized in the form of codes and guidelines in different countries (Bhagat and Bolton, 2008). Therefore, while doing research on corporate governance, researchers like Anderson and Gupta (2009) or Aldin et al. (2014) stressed on corporate governance codes. In general terms, corporate governance codes are important due to 5 reasons, 1- implementation of good corporate codes ensure equal participation of shareholders in annual general meeting (AGM) irrespective of size of their stake, 2- implementation of good corporate governance codes help companies to meet interest of shareholders in efficient manner, 3-through implementation of robust corporate governance codes, responsibility of each board members is being clearly understood, 4- corporate governance codes establish environment of ethical behaviour accross the company that limits the scope of commiting financial frauds by corporate officers and 5- good corporate governance codes help companies to present fair image among financial investors, due to trust factors, mentioned companies would easily convince these financial investors to invest (Ammanna, Oesch and Schmid, 2011; Madura, 2012). Due to such benefifits of implementation of corporate governance codes, Ammanna, Oesch and Schmid (2011) and Nankervis (2005) pointed out that effective corporate governance can be achieved through right integration corporate governance code. Corporate governance is the way in which company board undertakes and oversees the functioning of their companies through management, supervisors and high levels of authority. The corporate governance also makes sure that board members are held accountable for affairs of the company. This brings in implications for the company in terms of its behavior towards employees, stakeholders, customers, and its banks. It has been observed that sound levels of corporate governance provide integrity and efficiency that is reflected from financial market performance of the company (Madura, 2012). Mallin (2011) and Aldin et al. (2014) identified numers of benefits of practicing corporate governance for companies such as, 1-increase in access to financial and capital markets, 2- increasing propensity to survive in competitive business environment through merger, joint venture, strategic partnership or reduction of business risks through asset diversification, 3- increasing control over accounting practices that can improve profit margin, 4- decreasing the scope for rise of conflict of interest among owners, 5- reduction of the cost of credit by attracting equity investors and 6- minimizing financial and business risks help companies to ensure sustainable business growths. It is evident from the above discussion that practising corporate governance provides numerous benefits to companies and implementation of robust corporate governance codes can help companies to avoid financial misconducts. Likewise, Sustainability reporting is a relatively new discipline. Whereas financial reporting has had 150 years to mature, its non-financial equivalent has only had around 20 years. During the last 20 years we have seen enormous growth. Today many reports preduced globaly every year , up from less than 20 in 1992. Reporting is still growing with around 950 reports in 2011with great interest in north Amirica, Euroup and Asia (Corporate Citizenship ,2012). Beside the increasing of global environmental awareness and the campaign of sustainable development, the increasing trend of sustainability reporting is also supported by the increasing number of guidelines provided by various government organizations and industry bodies (Basamalah et al, 2005). Global Reporting Initiative (GRI) is one of them. It is a network-based organization that has pioneered the development of the sustainability reporting framework. Many organizations follow the framework and standard of disclosing sustainability report according to GRI. The perspective of sustainability provides a framework to create value which refers to both achieving sufficient profits and to satisfying the request of a diverse group of stakeholder (Lopez et al, 2007). There is a growing recognition among investment analyst that numerous business drivers upstream of a company’s profit and loss statement, including environmental, social, and governance, contribute to long-term financial performance and investment returns (KPMG, 2008). There is also a perception that organizations are producing sustainability reports primarily as a public relations exercise to give impression of concern over social and environmental issues (Hubbard, 2008). By disclosing sustainability reports, organizations will have generalized positive repercussions, where the aim is to fulfill the needs of different stakeholder, while also be benefited from the perspective of operations, finance, and reputation (Blyth, 2005, p.29 in Lopez et al, 2007). Investors are increasingly seeking to invest in socially responsible investments (SRI) in the companies that follow good social and environmental practices. Sustainability is currently a burning issue and a major cause of concern across the globe. At the World Commission on Environment and Development (WCED), Brundtland (1987) defined sustainability as “meeting the needs of the present generation without compromising the ability of future generations to meet their own needs.” The interest of investors in company’s non-financial performance has grown significantly over the past few years (Ernst & Young, 2009). In the wake of increased regulations and growth in level of awareness of stakeholders, the concept of corporate sustainability has been assuming great importance. World Business Council for Sustainable Development (2002) defined Corporate Sustainability as - “the commitment of business to contribute to sustainable economic development, and to work with employees, their families, the local community and society at large to improve their quality of life.” Today, the firms should take accountability for various beneficial and harmful impacts of their activities
on the overall society and environment in which they exist. Moreover, the firms should make proper disclosure of these impacts in an appropriate sustainability report, which provides a detailed 61 description of their governance structure, stakeholder engagement approach and triple bottom line performance. Elkington (1998) developed the term ‘triple bottom line’ to emphasize on three aspects - people (social), profits (economic) and planet (environmental). Global Reporting Initiative (2011) defines Sustainability Reporting as – “the practice of measuring, disclosing,
and being accountable to internal and external stakeholders for organizational performance towards the
goal of sustainable development.” In order for companies and business activities to contribute to sustainable development, the economic, social and environmental dimensions of development therefore must be taken into consideration (Williams, 2009). By minimizing environmental and social harm, without preventing adequate returns, this triple bottom line approach may prove to enable sustainable development (Barkemeyer et al., 2011; Elkington, 1994; Nguyen & Slater, 2010). Consequently, there is a need for firm activities to be properly designed and controlled to enable the industry’s contribution to the three dimensions of sustainable development (United Nations, 2012). The analysis of profits is an important thing for shareholders. Profits mean the income that come to them through dividends (Gibson, 1992), and therefore, according to previous studies, it should be reflected on the market value of the shares in the financial market that are traded between investors who are working to identify market value and what will the future be depending on contents of the information that can benefit their investments. (Research gap need improvement ) Ball and Brown (1968) studied the relationship between financial performance and market value of the shares that are measured by returns of share, and they came to the conclusion that there is a low explanatory relationship between profits and market value, there is an increased interest on the research on the relationship between corporate financial performance and market value by using different scales to measure profits and market value. They focused on those relationship as a scope of study, andfollowed many researchers who studied this relationship from different angles. Considering this, it is necessary to study the relationship between financial performance and market valueeven further, by using a new model in the hope of finding new results to add to the results of previous studies. The financial performance have an informational content which reflects those important financial decisions that are taken by the firm and this information could be reflected in the financial market if investors in the financial market employed this information and reversed them on the market value of shares. The analysis of profits is an important thing for shareholders. Profits mean the income gain through dividends (Gibson, 1992), and therefore, according to previous studies, it should be reflected on the market value of the shares in the financial market that are traded between investors who are working to identify market value and what will the future be depending on contents of the information that can benefit to the investments. It is a fact that the market value of any organization does not only depend upon the profit generation and market share but also on the public perception of the organization. The public perception can be measured mostly on the contents of corporate governance, corporate social responsibility and sustainibilty reports at the regular intervals. Most often, this is also known in business terms as the intangible assests of any organization. There are many definitions of intangible assests in various business studies. The intangible assets can be defined as the assets of any company that can be identified as non-monetary assets of an organization that does not have physical substance (International Accounting Standards Board, 2015). Some of the prominent examples of these assets can be given as the company goodwill, company trademarks and logos. As per many studies, the value of intangible assets contributes to a major part of the discrepancy that exists between the firm value in the market measured by the market capitalization of the company and CFP as per the company accounting records (Duam & Lev, 2004). Since its introduction, the importance of intangible assets is increasing in composition of the assets. Today this percentage is 62% of the company asset composition and it is accepted by managers, investors and the economists (Neely, et al 2003). In addition to the intangible assets, the correlation between corporate governance, managerial behavior and organizational performance have become an important part of the study for policy makers, academics and the practitioners. This invariably leads to an impact on CFP as well as the firm market value (Larcker, Richardson & Tuna, 2005). Sustainability report plays an important role in corporate performance mechanism, as the information of this report reflects the performance of the organization in various spheres such as corporate governance, social and environmental criteria. This process also includes the planning, identification and engagement of the stakeholders for the production, verification and continuous monitoring of performance (The Association of Chartered Certified Accountants, (2013). Research Originality There are many previous studies that have studied the impact of Corporate Financial Performance on the firm market value in the past. But, this study specifically targets the impact of the CFP on firm market value of the listed banks in Indonesia. In addittion to that, the study also uses some specific parameters such as market value sustainability report, corporate governance report and corporate financial performance of the selected banks during a specified time period to study the extent of the impact CFP has on firm market value. One of the most important factor in this relationship is the value creation efficiency of any organization. As the rate of value creation efficiency increases, the relationship between the Corporate Financial Performance and the firm’s market value becomes stronger with increasing value of the share for the investors of the company (Chen, Cheng & Hwang, 2005). There are three main components of the value creation efficiency and they are structural capital, human capital and physical capital. This study attempts to take a fresh look at the importance of value creation effiency. Value creation effiency cannot be underestimated as they are one of the vital aspects of the business strategy of the company. This is because, the effienciey of the value creation of an organisation also plays a vital part in the decisions fo the itvestors (Chen, Cheng & Hwang 2005). The qualty of the value creation of any organisation is the largest and vital aspect of its present and future success in any kind of the economy. So, it becomes a vital part of the study regarding the relationship of the CFP and the firm value in the market. Research Problem The Impact of CFP on firm market value has been documented in literature. Ideally, CFP on market value should be correlated, but studies on CFP and market value have yielded mixed results positive, negative and neutral impact. There are studies that concluded that the contradictory results of previous studies reporting positive, negative, and neutral impact were due to flawed empirical analysis. This study therefore seeks to fill the gap by examining the impact of CFP on firm market value of listed banks in Indonesia. It is a fact that the Indonesian banks are facing stiff competition from other domestic as well as international banks from all over the world. In addition to that, the Indonesian Government continues to review the performance at the regular intervals. They also continue to introduce tighter rules and regulations in order to regulate the activities of these banks. But these banks face many issues such as uniform and basic parameters for study of the impact of the relationship. The parameters of this study continue to change as per the situation and the bias of the researchers. So, the researchers are looking for a new model that will incorporate those parameters for the study of this topic that will incorporate all the necessary elements that are required for the comprehensive study (Chen, Cheng & Hwang, 2005). The main difficulties experienced during the study includes The importance given to each parameter and their percentage in final score Creation of a business strategy by banks for increasing the CFP & firm market value Due to these issues, the Indonesian banks are unable to plan for future growth of CFP & firm market value in order to compete in a successful manner. The main remedy of this issue is to study and understand “the impact of corporate financial performance on market value mediating by corporate governance and sustainability report” Research Benefits As mentioned in previous sections, the listed banks are facing two grave issues when they are making business strategy to increase their market share. One threat is the internal as well as external competition from global banks. The second issue relates to the government rules and regulations. Due to this, the impact of CFP on the firm market value makes a lot of difference and offers lot of benefits to the listed banks in Indonesia. Further, as the banks are the main instruments of financial control over the country for the Indonesian government, the impact and relationship of CFP and firms market value is very important for the country’s economy (Neely et al, 2003). Further, the benefits of the research can spread over to the future of the country. An in-depth study of this issue can benefit the banks with their existing policy modifications as per requirements in the present Indonesian financial environment. This study will also enable bank authorities as well as the government in formulating new policies to cope up with the increasing volatility of domestic and global financial markets. 1.2 Research Questions The research aims at analyzing the impact of corporate performance on the market value mediating by corporate governance and sustainability report in Indonesian banks. The research questions pertaining to this research shall be answered through an empirical studyof listed financial institutions in Indonesian stock market. 1. Dose sustainability report mediating the relationship between corporate performance and market value? 2. Dose corporate governance mediating the relationship between corporate performance and market value? 3. Does corporate performance have an impact on market value? 4. Does corporate performance have an impact on corporate governance? 5. Does corporate performance have an impact on sustainability report? 6. Does corporate governance have an impact on market value? 7. Does sustainability report have an impact on market value? For measuring the impact of corporate performance on market value that mediating by corporate governance and sustainability report 1.3 Research objectives The main objectives of this study is to investegate the impact of corporate governance and sustainability report on the market value. Specifically, the study investigate: 1. To investigate the relationship between corporate performance and market value mediating by sustainability report. 2. To investigate the relationship between corporate performance and market value mediating by corporate governance 3. To investigate the impact of corporate performance on market value. 4. To investigate the impact of corporate performance on corporate governance 5. To investigate the impact of corporate performance on sustainability report 6. To investigate the impact of corporate governance on market value. 7. To investigate the impact of sustainability report on market value. \ References Larcker, D.F, Richardson, S. A, Tuna, I, ( 2005 ), How Important is Corporate Governance?, The Wharton School University of Pennsylvania. [ONLINE], Accessed at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=595821 The Association of Chartered Certified AccountantsSingapore, (2013), “The Business Benefits of Sustainability Reporting in Singapore, ACCA Sustainability Roundtable Dialogue On 24 January 2013”. Chen, M.C, Cheng, S.J., & Hwang Y. (2005) "An empirical investigation of the relationship between intellectual capital and firms’ market value and financial performance", Journal of Intellectual Capital, Vol. 6 Iss: 2, pp.159 – 176 [Accessed 12 June, 2015] International Accounting Standards Board (2015), [ONLINE], Available at: http://www.iasplus.com/en/standards/ias/ias38, [Accessed 12 June, 2015]. Duam J.H., Lev. B. (2004). 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