Corporate Governance Quality on Performance of Firms - Research Proposal Example

Corporate Governance Quality on Performance of Firms Contents INTRODUCTION 3 RATIONALE FOR THE RESEARCH 4 RESEARCH AIM 5 OBJECTIVES 5 MAIN RESEARCH QUESTION: 5 HYPOTHESES 6 EMPIRICAL MODELS 6 THEORETICAL FRAMEWORK 8 PHILOSOPHICAL FRAMEWORK 10 LITERATURE REVIEW 11 METHODOLOGY 13 ETHICS 14 EXPECTED FINDINGS 15 LIMITATIONS 15 References 16 INTRODUCTION Corporate governance and financial performance have been linked in a number of studies over the years and this is now a basis of theoretical framework for any study that is conducted incorporating these two variables. In this context, corporate governance identifies the ethical principles that the organization follows and the financial performance indicates the market value that the firm fetches in the secondary market, both in terms of share value and the value of the firm in total. A large number of firms in the United States boast of the fact that they follow strict ethical codes and because of which their financial performance is impacted positively. In this scenario, a connection between Brazilian firms’ performance and their code of conduct and corporate governance principles has yet to be established. (Preston & Bannon, 1997; Velde, Vermeirm & Corten, 2005; Fuerst & Kang, 2000) Theoretically, when the market is in perfect state and there is complete information available in the market, the financial performance of any organization should be linked directly to its management and corporate governance principles. A study reveals that theoretical concept of a positive link between financial performance and corporate governance is present and this primarily on the basis of the fact that investors have confidence in such a company that has good corporate governance principles. The study indicates that investors pay more than twenty eight percent higher for organizations that have better corporate governance policies, and this is the case for emerging markets of which Brazil is one such example. The research took the price to book ratio of one hundred and eighty eight organizations in six emerging markets to study their financial performance against their corporate governance policies. The research found that various variables that would measure financial performance, along with the companies’ price to book ratio, were all higher for those organizations that had better governance policies in place. In addition, the research highlights the fact that these corporate governance principles have a higher impact in countries which are termed as emerging markets in comparison to developed markets such as the United States. This is specifically because such developed markets have shown great examples of disasters where corporate governance principles have failed despite correct and relevant policies in place. Therefore, investors have more trust in such emerging markets where organizations are bound to grow and develop along with the market. Thus the case of Brazil is relevant in this situation in terms of an emerging market where the study of corporate governance and financial performance can be evaluated. Bauer, Guenster & Otten, 2004; Brown & Caylor, 2006; Brown & Caylor, 2006) RATIONALE FOR THE RESEARCH The rationale for the intended research is underpinned by the personal interest of the researcher in the phenomena to be observed i.e. Corporate Governance Quality and Firm Performance on the basis of an empirical approach and attempt to understand the impact of the impact of quality of Corporate Governance on Firm Performance in the presence of audit quality. The intended research offers to provide insight in to Corporate Governance quality issues that may be relevant to defining the relationship that exists between the quality and control variables (Independent Variables), together with firm characteristic variables (such as firm size, firm OCF etc) on Firm Performance (Dependent Variable) and offer an explanation policy contribution to the improvement of the Corporate Governance mechanisms and function. RESEARCH AIM The overall aim of this research is to explore Corporate Governance Quality in Firm Performance in the case of Brazil with a purpose to assess the performance of companies and the impact of Corporate Governance Quality on company market value. As indicated earlier, emerging markets such as Brazil have a stronger link between corporate governance principles and corporate governance quality against the market value of the organization. Therefore, this performance measurement and evaluation can help reveal the relationship between financial performance as well as corporate governance quality, as to whether it holds true or is rejected. OBJECTIVES The following objectives have been developed for the study based on the aims of the research highlighted above. These objectives will help define the relationship between corporate governance quality and the financial performance of firms in Brazil: a. To assess the relationship and the impact of Corporate Governance Quality and ROA on Brazilian listed firms. b. To assess the relationship and the impact of Corporate Governance Quality and share price on Brazilian listed firms. c. To assess the relationship and the impact of the Corporate Governance Quality and Δ Share price on the Brazilian listed firms. MAIN RESEARCH QUESTION: Following questions have been developed based on the objectives in order to study the quality of corporate governance and it’s impacted on the performance of the firms in Brazil: a. What is the relationship and the impact between Corporate Governance Quality and ROA? b. What is the relationship and the impact between Corporate Governance Quality and Share price? c. What is the relationship and the impact between Corporate Governance Quality and Does Δ Share price? HYPOTHESES Based on the research questions highlighted earlier, the following hypotheses have been developed and will be tested in order to evaluate the relationship of corporate governance quality with financial performance of firms: H1. There is a contemporaneous relationship between Corporate Governance Quality and Firm Profitability. H2. There is a positive and significant influence of Corporate Governance Quality on firm’s market value. H3. There is a significant relationship between Corporate Governance Quality and the performance of the company. EMPIRICAL MODELS The empirical models that the research will follow in order to study the relationship and significance of corporate governance with financial performance of Brazilian firms include the following: Objective A Research Question A The CGI is constructed for proxy the quality of governance and a cross- sectional OLS model is used to analyze the relation between CG and by the above mentioned variables. The model to be tested is the following: CGI = α +β1 FirmSIZEit + β2TANGit + β3ADR23it + β4 N2NMit + β5OWN it+ β6PERFit +Ɛit CGI Corporate Governance Index, proposed by Leal and Carvalhal-Da-Silva (2007), based on binary questions and scaled on 0-24 range. FirmSize Firm /Size, natural logarithm of book value of total assets TANG Tangibility of Assets, total fixed assets divided by net operational revenues. ADR23 Participation in Level 2 or 3 ADR Program, Dummy variable equal 1 if firm issues Level 2 or Level 3 ADR’s N2NM Participation in Bovespa Governance special Listing, Dummy variable equal to 1 if the firms is listed in the top two segments (Bovespa Level 2 and New Market). OWN Ownership structure, PERF Performance, represented by Tobin’s q (Q) Objective B Research Question B Share Price = α + β1 CGQit +β2 OWNSTRUCit + β3 CAPSTRCit + β4LIQit + β5 PAYOUTit + β6 PROFITit+ β7REVGit + β8Log (REV) it + β9 TANGit+ Ɛit SHARE PRICE Value OWNSTRUC Ownership structure CAPSTRC Capital Structure (Financial Leverage) LIQ Stock Liquidity PAYOUT Stock Payout Ratio PROFIT Operational Profitability REVG Growth Opportunities Log (REV) Firm Size TANG Type of Operations (asset tangibility) Objective C Research Question C PERF = α + β1 CGQit +β2 GROWTHit + β3 FirmSizeit + β4TANGit + β5 LEVit+ Ɛit PERF Performance, represented by ROA CGQ Quality of CG measured using Logitreg, firm i at time t GROWHT Future Growth Opportunities, firm i at time t Firm Size Firm size on the basis of Total Assets, firm i at time t TANG Composition of firm’s assets, firm i at time t LEV Firm leverage, firm i at time t THEORETICAL FRAMEWORK Arjoon (2005) argues that corporate governance is very important to be complied with for the reason that organizations may comply with all the rules and regulations in terms of legality however, there are several ethical boundaries that must be complied with and for those, the organization needs to have strong corporate governance principles that need to be complied with. In order to build trust within investors so that they invest in the company’s shares, it is important that the organization has a strong compliance policy for corporate governance other than compliance to legalities. Arjoon (2005) also suggests that accountability is not the only way the organization should ensure compliance. Unless and until organizations include responsibility in the equation and ensure compliance of corporate governance policies, ethical grounds cannot be met and as a result, fraudulent practices are involved. This can severely impair the relationship of investors and stakeholders with the organization. This is the primary test for any organization and its financial performance or market value in terms of investor mindset. (Arjoon, 2005) The relationship between corporate governance and financial performance has been linked on the base of several constructs and theoretical grounds. It has been empirically proven in developed markets that financialperformance and market value of the firm is strictly related to governance policies and principles of the firm. In this context, emerging markets have shown significant promise with respect to the ideology of corporate governance and its positive correlation to financial performance and market value of organizations. It has been argued by many researchers that it is still not an established fact and thus still a theory that strong corporate governance principles lead to better financial performance and it depends on the outlook of the investors which may change due to any reason towards an organization and may subsequently inversely impact the market value of the firm despite having strong corporate governance. In this respect, emerging markets show great promise with respect to corporate governance linking firm’s market value together. (Arjoon, 2005) PHILOSOPHICAL FRAMEWORK In the context of this research, it is important to establish a philosophical framework against which the construct of corporate governance and its relationship to financial performance of Brazilian firms will be studied. In this framework, two areas of philosophy can be explored, positivism and interpretivism. Positivism relates to that branch of science where both observation and mathematical analysis of data can form the body of knowledge to help reach towards conclusion for the hypotheses being evaluated. This body of knowledge is authentic because it involves actual data to be observed and then analyzed based on the mathematical or statistical constructs established for the hypotheses to be tested. This is generally termed as empirical analysis and is one of the most used forms of hypothesis testing used in today’s research. In this context, positivism is related to epistemology which in turn is the collection of knowledge and addresses the scope as well as the nature of knowledge relating it the construct of analysis to gather the body of knowledge. The field of science called ontology is also related to positivism since it involves the understanding of reality and then evaluating it is addressed through positivism. Another area of science is termed as interpretivism and is also generally termed as positivism. This branch of philosophy is set in ethnographic research and involves primarily observation rather than statistical or empirical interpretation. In this regard, all elements of critical research are avoided in this branch of science for natural order and sequence of activities. This branch holds true for certain types of research in the social context, however, with research grounded in theoretical frameworks, this philosophical framework does not hold true, as the theory will have to be proven or disproven through empirical evidence which is gathered through analysis of data. LITERATURE REVIEW Organizations have developed corporate responsibility and governance policies fairly recently as the ideology has grown and gotten shape in the past couple of decades. At this point in time, at least fifty percent of organizations in the Fortune 1000 list have a regular corporate social responsibility report that they issue. In addition to that, many stakeholders involved in and are knowledgeable about the ethical responsibilities that organizations need to fulfill towards them. There is an increasingly higher demand for continuous improvement in terms of ethics, responsibility and economic performance underlain with transparency. Each organization has a different construct with respect to corporate governance and corporate social responsibility however; the ideology of each firm is the same; to build transparency in its practices in order to build a reliability factor for its stakeholders. The differences in corporate governance practices stem primarily from a few main factors including the size of the organization, the industry in which the organization is based in, the culture of the organization, the progress of the firm with respect to its corporate governance activities and the demands of the stakeholders involved. (Core, Guay & Rusticus, 2006; Core, Holthausen & Larcker, 1999; Chiang, 2005) It is important for all organizations to focus on theircorporate governance principles to be part of the strategic planning and ideology of the organization otherwise there will not be any commitment from the employees or the management to perform well within the realms of these principles. In this context, investors tend to believe in those companies that have strong corporate governance principles which also match the competencies and strategic outlook of the organization. There are several benefits that the organization derives with respect to effective corporate governance first and foremost being the reputation of the organization. Investors appreciate organizations which have staunch principles of corporate governance and which are being followed strictly. Subsequently, investors place higher value to such organizations as well which in turn allows the organization to enjoy benefits such as loans at better rates, market value of the firm to go higher, and the organization to enjoy betters rates from suppliers. (Berglof, 1997; Bhagat & Bolton, 2008; Farber, 2005) It has been noted through research that organizations that tend to become more transparent and the management tends to follow ethical principles when corporate governance principles are enacted within the organization. In this context, the organization’s risk profile reduces and it makes the organization perform better, against organizations which face volatility and unstable growth patterns because of lower quality corporate governance principles. In this context, lower discount rates are generally utilized by the investors to calculate the market value of the organization. (Gompers, Ishii, & Metrick, 2003; Klapper & Love, 2004) It is also important to note that organizations which follow good corporate governance practices tend to be responsible and this reflects in the operational costs of the organization as well. As a result, the organization when follows best practices is noticed by investors for making a difference, and trying to obtain a competitive advantage with respect to its peers inthe industry. Researchers indicate that there are two types of impacts on the firm when it follows good corporate governance practices, shorter term financial results which are positive – abnormal returns, and longer term financial results or impacts which are again positive – accounting performance. In this context, longer and shorter term evaluations on rates of return on stock indicate that the organizations with better corporate governance and social responsibility policies and who followed them effectively, had better returns in comparison to their peers. (Mayer, 1996; Porta, Silanes, Shleifer & Vishny, 2000) Other than financial performance, it has been indicated in various studies that operating performance of the firms also improves when they implement better corporate governance practices within the culture of the organization. This indicates that even with the perception of the investor, the real situation lies in the operations of the organization which improves as a result of which financial bottom lines are affected positively, leading to positive investor sentiment. (Larcker, Richardson & Tuna, 2007; Karpoff, Malatesta & Walkling, 1996) This framework of study helps in building the hypothesis that the Brazilian firms may actually be better off if they had better corporate governance procedures. Moreover, those Brazilian firms which have better corporate governance procedures would eventually have better financial performance and may have better market value as well. METHODOLOGY The study primarily aims at collecting secondary data from various sources published by the firms which are to be selected for the research. Other objective yet authentic sources of data will also have to be collected in order to develop a well rounded study from which empirical analysis can be conducted. In order to do that, two categories of firms will be created, one with good corporate governance procedures and other with no or poor corporate governance procedures. A snowball sample for each category will be made for existing Brazilian firms, and 10 firms will be selected for each category. Using the positivism approach to this research, the ordinary least square methodology will be utilized and a multivariate analysis will be done on the data collected based on the hypotheses and empirical models created in the proposal earlier. The concept of internal and external validity have been maintained by designing the empirical models and the empirical framework on a solid grounds of theoretical framework that defines how corporate governance policies may be related to the financial performance of a firm. Internal validity is also maintained through multiple regressions conducted on the data to be collected for various firms in Brazil that have corporate governance principles enacted within them. External validity of this research would also be maintained through the usage of historical background in which the same empirical models have been used for the purpose of studying the research question at hand, which have been used in other developed countries. This research therefore, can be scaled to other emerging markets aswell after being applied to Brazil. For reliability, since this study will be longitudinal in nature, some reliability factor is in built into the research. However, with respect to other variables being constant in the economy, this empirical model to be used can be scaled to other time periods and other economies as well. There is limited scope of triangulation in the study since the data collected would be from secondary sources and can be analyzed on the basis of the same theoretical framework. However, it can be evaluated against results from other economies to identify whether it holds true or not. ETHICS Since all data is sourced from publically available dimension, no issues relating to ethical concerns arise. Nevertheless, the researcher will abide by the university Code on ethics. The concept of ethics does not arise in this research as seriously since the data collection would not be primary and thus bias cannot be introduced. Since the research will be empirical in nature, therefore, bias in numbers and evaluation cannot be introduced either. EXPECTED FINDINGS With the analysis of literature and the study of the variables involved in this research, it is expected that the answer would be fairly simple, which is that Corporate Governance Policies and Principles have an impact on FinancialPerformance of a firm in Braziland this impact would be positive in nature. Studies have primarily been conducted in developed economies, but due to the nature of emerging markets such as Brazil where investors are willing to take higher risks against higher returns, they would definitely move towards investing in such organizations that are of lower risk in comparison to their peers, with respect to stringent corporate governance principles. LIMITATIONS On the basis of this research, data sources are extremely limited because the only information that can be used will have to be available publically, and therefore, this can lead to biased information against those firms which do not have as much information available for them. Other than that, time is a limitation for this study because of which snowballing sampling techniques would have to be utilized where a random sample after careful analysis would have been a better choice. Other than that, there are limited literature sources available which have similar phenomenon and studies conducted on emerging markets and the trend of market value of firms with respect to corporate governance. References 1. Arjoon, S. 2005. Corporate Governance: An Ethical Perspective. Journal of Business Ethics. 61 (4) 343-352 2. Bauer, R, Guenster, N & Otten, R. 2004. Empirical evidence on corporate governance in Europe: The effect on stock returns, firm value and performance. Journal of Asset Management. 5 (2), 91-104 3. Berglof, E. 1997, Reforming corporate governance: redirecting the European agenda, 4. Economic Policy, p. 93-123. 5. Bhagat, S, & Bolton, B. 2008. Corporate governance and firm performance, Journal of Corporate Finance, 14 (3), 257-27 6. Brown, L and Caylor, M. 2009. Corporate governance and firm operating performance. Review of Quantitative Finance and Accounting. 32(2), 129-144 7. Brown, L., and Caylor, M. 2006. Corporate governance and firm valuation. Journal of Accounting and Public Policy 25: 409-434. 8. Chiang , H. 2005. An Empirical Study of Corporate Governance and Corporate Performance, Journal of American Academy of Business. 6(1) 9. Core, J., W. Guay, and T. Rusticus. 2006. Does weak governance cause weak stock returns? An examination of firm operating performance and analysts expectations. Journal of Finance 61: 655-687. 10. Core, J, Holthausen, R & Larcker, D. 1999. Corporate Governance, CEO Compensation, and Firm Performance. Journal of Financial Economics 51, 371-406 11. Farber, D. 2005. Restoring trust after fraud: Does corporate governance matter? The Accounting Review 80: 539-561. 12. Fuerst, O & Kang, S. 2000. Corporate Governance, Expected Operating Performance, and Pricing. Yale School of Management. 13. Gompers, P., J. Ishii, and A. Metrick. 2003. Corporate governance and equity prices. Quarterly Journal of Economics 118: 107-155 14. Karpoff, J, Malatesta, P & Walkling, R. 1996. Corporate governance and shareholder initiatives: Empirical evidence, Journal of Financial Economics, 42 (3). 365-395 15. Klapper, L & Love, I. 2004. Corporate governance, investor protection, and performance in emerging markets, Journal of Corporate Finance, 10 (5), 703-728, 16. Larcker, D, Richardson, S & Tuna, A. 2007. Corporate Governance, Accounting Outcomes, and Organizational Performance. Accounting Review. 17. Mayer, C. 1996, Corporate governance, competition and performance, OECD Economic Studies, 27, p. 7-34. 18. Porta, R, Silanes, L, Shleifer, A & Vishny, R. 2000., Investor protection and corporate governance, Journal of Financial Economics, 58(1), 3-27 19. Preston, L & Bannon, D. 1997. The Corporate-Social Financial Performance Relationship. Business and Society. 36 (4) 419-429 20. Velde, E, Vermeirm, W & Corten, F. 2005. Corporate social responsibility and financial performance. Corporate Governance. 5 (3) 129 – 138 Read More