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The purpose of this chapter is to highlight and discuss the literature related to board characteristics and performance in GLCs. The chapter is organised into three parts. Firstly, the chapter elaborates on the theoretical frameworks pertaining to board attributes and performance. Secondly, the chapter discusses the relationship between elements of corporate governance and firm's performance. Finally, the chapter unveils some the corporate governance code employed by the countries.
Agency theory emphasises the role of the board in monitoring the behaviour and performance of executives (Fama and Jensen, 1983; Jensen and Meckling, 1976). They defined the managers of the company as the 'agents' and the shareholder as the 'principal' (in their analysis there is one shareholder versus the 'managers'). In other words, the shareholder, who is the owner or 'principal' of the company, delegates day-to-day decision making in the company to the directors, who are the shareholder's 'agents'. The problem that arises as a result of this system of corporate ownership is that the agents do not necessarily make decisions in the best interests of the principal. One of the principal assumptions of agency theory is that the goals of the principal and agent conflict. In finance theory, a basic assumption is that the primary objective for companies is shareholder wealth maximization. In practice this is not necessarily the case. It is likely that company managers prefer to pursue their own personal objectives, such as aiming to gain the highest bonuses possible. Managers are likely to display a tendency towards 'egoism' (i.e., behaviour that leads them to maximize their own perceived self-interest: Boatright, 1999). This can result in a tendency to focus on project and company investments that provide high short-run profits (where managers' pay is related to this variable), rather than the maximization of long-term shareholder wealth through investment, in projects that are long term in nature. Hence British industry has been notorious for 'short-termism'.
Unlike agency theory, stewardship theory assumes that managers are stewards whose behaviors are aligned with the objectives of their principals. The theory argues and looks at a different form of motivation for managers drawn from organizational theory. Managers are viewed as loyal to the company and interested in achieving high performance. The dominant motive, which directs managers to accomplish their job, is their desire to perform excellently. Specifically, managers are conceived as being motivated by a need to achieve, to gain intrinsic satisfaction through successfully performing inherently challenging work, to exercise responsibility and authority, and thereby to gain recognition from peers and bosses. Therefore, there are non-financial motivators for managers.
The theory also argues that an organization requires a structure that allows harmonization to be achieved most efficiently between managers and owners. In the context of firm's leadership, this situation is attained more readily if the CEO is also the chairman of the board. This leadership structure will assist them to attain superior performance to the extent that the CEO exercises complete authority over the corporation and that their role is unambiguous and unchallenged. In this situation, power and authority are concentrated in a single person. Hence, the expectations about corporate leadership will be clearer and more consistent both for subordinate managers and for other members of the corporate board. Thus, there is no room for uncertainty as to who has authority or responsibility over a particular matter. The organization will enjoy the benefits of unity of direction and of strong command and control.
Board composition can also be understood from the institutional theory perspective. The key argument here is that organizations are constrained by "social rules" and "taken for granted" conventions that shape their practice and structure (Ingram and Simons, 1995). The legitimization of norms and practices within an "organizational field" increases with the degree of their diffusion in the field (DiMaggio and Powell, 1983; cited in Infram and Simons, 1995). As diffusion continues, the propriety of norms and practices becomes widely accepted, and organizations face greater pressure to adopt them to maintain legitimacy (Oliver, 1990). In the context of board design, for instance, bigger firms are likely to set the standards and the smaller ones to follow.
Resource dependence theory
The problem of who controls the firms, discussed above using the property rights and agency paradigms, can also be explained in the context of the resources needed to succeed and the external environment where the organization operates. Resource dependence literature explains that the answers to this question are more of a result of pattern of resource exchanges than a cause of such exchanges (Pfeffer and Salancik, 1978). Of course, organizations are also controlled and constrained by external and institutional factors that we must consider to fully understand why boards are the way they are in the context of these organizational theories.
Resource dependence perspective has been used to examine a number of forms of intercorporate relations such as mergers and joint ventures. In these cases, firms are looking for an important resource or discretion over the resource allocation and use (Pfeffer and Salancik, 1978). We can understand corporate board composition as a tool to gain access to important resources as well. For example, a start-up firm may hire a prestigious director in order to facilitate access to capital. In the context of emerging markets, this is particularly a relevant issue due the larger asymmetries of information among market participants.
Another factor that can be explained in the context of this theory is the use of outside directors for their political background (political resource). Agrawal and Knoeber (2001) found that the incidence of outside directors with political and law background was higher among the firms in economic sectors where politics were more relevant (e.g. electric utilities, large manufacturing firms). Furthermore, Klein (1998) found that firms place affiliated (gray) directors on their board to serve the specific, strategic needs of the firm.
Corporate Governance and Firm Performance
The relative effectiveness of corporate governance has a profound effect on how well a business performs. Most of the literature on corporate governance identifies board characteristics and their impacts on the organizational outcomes. Previous studies have examined the effects of such factors as board size (Dalton et al, 1999; Pfeffer, 1973; Pfeffer and Salancik, 1978; Singh and Harianto, 1989) and board composition (Baysinger et al, 1991; Chaganti et al, 1985; Kosnik, 1987; Schellenger et al, 1989) on strategic decisions and organization performance.
Board of director and performance
The board of directors' effectiveness can be linked to its characteristics in a way that the effective and active board can minimize the opportunistic behaviour of unscrupulous managers, hence, protecting the interest of shareholders. The Malaysian Companies Act 1965 (Amended 2006) and MASB on presentation of financial statements emphasize the role and responsibility of the board of directors in ensuring that the financial statements are prepared in accordance with applicable accounting standards.
Board of directors is important because they are intended to control mechanism for management opportunism. They have duty to be effective stewards and guardians of the company in term of setting strategic direction and overseeing the conduct of business.
Moreover, the board of directors should also perform its function effectively since compliance with accounting standards is not enough to ensure the absence of manipulation in financial statements (Saleh et al., 2005). Therefore, in order to handle its monitoring responsibilities effectively, it might depend on the so-called form of corporate governance, such as structure and composition (Peasnell et al., 2005), or it might rely on the substance of corporate governance, such as the diligence and commitment of directors (Sarkar et al., 2008; Chtourou et al., 2001).
Proportion of independent directors and GLC's performance
One of the often researched area on board of directors is the composition of boards especially the impact of independent directors towards the performance of the firm. Rashid, Fairuz and Husein (2010), analysed relationship between board role typology and firm performance of 277 non-financial listed Malaysian firms from 2002-2007 concluded that firm-board with high representation of outside and foreign directors tend to have better performance compared to those firm-boards that have a majority of insider executive and affiliated non-executive directors. McCabe and Nowak, (2008) did a qualitative study on 30 directors of Australian public-listed companies using a grounded research approach is in the opinion that majority of independent minds expressing multiple points of view was perceived to reduce the board room hazard of "group think."
However, there is also concern that the ratio of outside directors can be too high and backfires. Byrd and Hickman (1992) found that based on sample of 128 tender offer bids by 111 firms, it is possible that having too many independent directors will lead to negative effects on the firm's value. This was further supported by Bhagat and Black (1997) study in Australia context, that firm with too many independent directors had weaker share price performance
This raises the question of whether or not there is an optimal board composition. Noe and Rebello (1997) analysed this problem theoretically and the answer seems to be affirmative. These authors argued that governance mechanisms can ensure the implementation of efficient policies if independent outsiders participate in the decision process, if conflicts and disagreement between board members can lead to termination, and finally, if the group of insiders on the board are divided into interest groups. An interesting result is that while outside board members may not have any inside information or monitoring ability, they must as a group have sufficient power to block management-sponsored policies.
Board independence is the most debated corporate governance issue faced by corporations. The ASX (2003), in its second of ten corporate governance principles, recommends that boards of listed organisations should comprise a majority of non-executive, independent directors so that the board is able to appropriately discharge its responsibilities and duties. It is widely accepted that board independence increases board effectiveness and thereby enhances the firm's overall performance (Bonn, 2004; Shah et al., 2008; O'Neal and Thomas, 1995). Outside directors can better monitor management due to their non-official position in the organization (Donnelly and Mulcahy, 2008) and have incentives to build reputations as expert monitors which discourage them from colluding with inside directors (Carter et al., 2003). Hence a lack of material interest and independent judgement would encourage board members to act in favour of both the shareholders as well as legitimate stakeholders. Many previous studies highlight the importance of independent directors in firm's performance. Therefore it is hypothesised that GLC's performance is more likely to increase with an increase in the proportion or number of independent, non-executive directors on the board.
Board size and GLC's performance
Another factor usually investigated in the research literature on boards of directors is the impact of board size on performance. Board size, that is, the number of directors on the board, plays an important role in monitoring the board's performance. Studies that examine board size and performance are briefly reviewed before considering studies that directly relate board size with disclosure. Board size has been found to be both positively and negatively associated with the firm performance. Most of the literature argues in favour of smaller sized boards and importance is attributed to limiting board size (Adams et al., 2005; Cheng, 2008; Jensen, 1993; Lau et al., 2009; Lipton and Lorsch, 1992; van Ees et al., 2003; Yermack, 1996). With a sample of 452 large U.S. firms during 1984 to 1991, Yermack (1996) found that board size was negatively related to firm value. He showed that smaller boards are more likely to dismiss the CEO following periods of poor performance and to key CEO compensation to firm performance.
Eisenberg et al. (1998) similarly found significant negative correlation between board size and profitability. For a sample over the period of 1992 to 1994 of approximately 900 firms in Finland - including of course many smaller firms-these authors studied possible effects of larger boards such as problems of communication and coordination and greater control by the CEO. These findings support the interpretation that board size influences firm value (and not the reverse).
Interestingly, the results of Eisenberg et al. were consistent with Yermack's despite being based on a very different sample, namely smaller and non-U.S. firms. But the question remains whether smaller and non-U.S. firms can be assumed to be affected in the same way, by the same factors, as the larger U.S. firms that typically constitute research samples.
Although there is considerable empirical research on corporate governance in general and on boards of directors in particular, this research is almost exclusively based on major U.S. corporations, and it is very likely that the conclusions drawn will be not be applicable in a different context.
Smaller sized boards are more effective in monitoring management's actions (Lakhal, 2005) and can function effectively as they can come to a unanimous decision easily (Jensen, 1993; Cheng, 2008). Other studies argue that larger boards are more effective as they can bring more experience and knowledge and offer better advice (Dalton et al., 1999; Bonn, 2004). However major drawbacks are identified with larger boards, including a lack of communication, slow decision making, and a lack of unanimity that ultimately affects board effectiveness and efficiency. In addition, Australian firms are reported to have smaller sized boards that in other countries (Bonn, 2004; Lee and Shailer, 2008) and hence it is hypothesized that the relationship between board size and GLC's performance will be negative.
Director's qualification and GLCs performance
Researchers have increasingly examined directors' skills and knowledge as potential determinants of board performance. In order for boards to provide strong oversight and relevant input into strategic decisions, many have argued that companies must ensure that board members have the right mix of skills and knowledge. Board members should possess both functional knowledge in the traditional areas of business expertise such as accounting, finance, legal, or marketing, as well as industry-specific knowledge that would enable them to truly understand specific company issues and challenges (Forbes and Milliken, 1999; Roberts et al., 2005). Examining the impact of board capital on board performance, researchers have found evidence of a positive correlation between directors' knowledge and skills and the board's monitoring role and strategic involvement (Carpenter and Westphal, 2001; Zona and Zattoni, 2007). These studies suggest that knowledge and skills play a critical role in increasing board involvement in strategy, since more knowledgeable directors should be in a better position to understand strategic issues and contribute meaningfully to strategy development and evaluation.
According to the resource dependence theory, a board can constitute a strategic resource for the firm.
A qualification that shows you've achieved a certain educational standard. Traditional academic qualifications you can get from school demonstrate a certain level of analytical and critical skill. These are important skills needed in most jobs.
Professional and work-related qualification
Demonstrate practical skills as well as theoretical knowledge. You do not need academic qualifications to gain them. It is generally awarded by professional bodies in line with their charters.
Lorsch (1995) acknowledges that the board's ability to govern also depends on the knowledge of directors, which comes from their working experience.
Thus, higher level of educational qualification like PhD will function as a strategic resource (Carpenter and Westphal, 2001). However, in Malaysia and Australia, there was no prerequisite for a person to be appointed as director to a company. Moreover, for the case of GLCs / GOCs, directors are among those public servant retiree with relevant working experience. Educational qualification such as PhD will act as a mix of competencies and capabilities that help in executing the governance function (Carpenter and Westphal, 2001).
Proportion of female directors and GLCs performance
Boards are traditionally composed of only male members. The presence of women on the board leads to gender diversity. It is generally accepted that female board members are more independent because they are not part of the ''old boys'' network (Carter et al., 2003). According to Ryan and Haslam (2005), women are more likely to be placed in positions of leadership in circumstances of downturn. The implication is that the presence of women on the board could be perceived by shareholders that significant change is on the way, and making them more confident in the company's success, which results in increase in share price. Diversity in general is considered to improve organizational value and performance as it provides new insights and perspectives (Fondas and Sassalos, 2000; Carter et al., 2003; Letendre, 2004; Huse and Solberg, 2006) and provides for representation of different stakeholders for equity and fairness.
The level of diversity on a board affects their decisions and activities (Adams and Ferreira, 2004) and has been reported as having a positive effect on firm performance in Australia (Bonn, 2004). One considerably debated characteristic of board diversity is gender. The importance of gender diversity in the boardroom has been raised in recent proposals for governance reform (Adams and Ferreira, 2004). It is increasingly being viewed that women can make a significant contribution to the board. Huse and Solberg (2006) found that women are more committed and involved, more prepared, more diligent, ask questions and ultimately create a good atmosphere in the boardroom. Similarly, Adams and Ferreira (2004) found that more women on the board improves the decision making process, enhances board effectiveness and that women have better attendance/participation. Another argument in favour of having more female directors is that they are able to enhance the board's independence (Kang et al., 2007). Female directors' active involvement, better preparation, independence and other unique qualities, enable them to make a significant contribution to complex discussions and decisions such as decisions that expose stakeholders' interest to higher risks. Hence it is expected that more female directors on a board will increase the performance of the GLC.
3.3.7 Firm size
Scholars have suggested that internal governance structures are substitutable and the firms can choose appropriate governance options based on what is right for them (Booth et al., 2002; Peasnell et al., 2003). As the complexity of the firm increases, board size may increase due to need for advice and environment monitoring (Pfeffer, 1972; Zahra and Pearce, 1989). Thus, board duality may be dropped as a trade-off in favour of director/insider ownership to ensure firm performance through alignment of interests between shareholders and directors. For this study, total asset will be used as a proxy for firm size. Firm size will be measured by the logarithm of total assets.
3.3.8 Firm age
Firm age is the number of years for which a firm has been in operation, starting with the date of incorporation. Studies have shown that firms go through financial growth cycle and their capital structures vary with their age (Berger and Udell, 1998). New firms are expected to have smaller earnings than old ones because they have less experience in the market, are still building their market position, and normally have a higher costs structure. Older firms may be reaching the end of their product life cycle. This suggests that complexity increases with firm age. We control for firm age which log of years since incorporation.
Public Accounts Committee
Public Accounts Committee (PAC) is established under the constitution with the purpose of making sure public funds are being administered and spent according to its intended purpose that was passed by the parliament. This committee comprised of Chairman and Vice Chairman and normally comprises of members with various knowledge and experience. Both Malaysia and Australia have had their PAC established under provision of the constitution. PAC have to power to summon any individual or any representative of firm that administer or use public fund to disclose and explain any issues that in the opinion of PAC have public interest. Given the mandate, PAC is an integrity oversight panel for GLCs stakeholders and shareholders.
In the case of Malaysia, PAC assess and appraise accounts of the Malaysian Government and the provision of funds which has been authorised by the Parliament to local states, accounts of administrative bodies and organizations which utilise state's provisions. Examples of PAC queries on GLCs are why Pos Malaysia is making loss, why Sime Darby incurred RM1.6bil loss in energy and utilities division, the issue of Syarikat Prasarana Negara Bhd unproper disposal of buses, Port Klang Free Zone (PKFZ) project and the MRR2 highway construction and toll collection.
Discussion on MCCG 2012 and ASX 2010
With regards to corporate governance code in Malaysia and Australia, there are a lot of similarity between the two in term of elements of corporate governance as both document was adapted from United Kingdom's corporate governance code. The Malaysian Code on Corporate Governance (MCCG), first issued in March 2000, marked a significant milestone in corporate governance reform in Malaysia. The code was later revised in 2007 to strengthen the roles and responsibilities of the board of directors, audit committee and the internal audit function. The Malaysian Code on Corporate Governance 2012 (MCCG 2012) focuses on strengthening board structure and composition recognising the role of directors as active and responsible fiduciaries. They have a duty to be effective stewards and guardians of the company, not just in setting strategic direction and overseeing the conduct of business, but also in ensuring that the company conducts itself in compliance with laws and ethical values, and maintains an effective governance structure to ensure the appropriate management of risks and level of internal controls. The current version of the corporate governance guidelines in Australia, Corporate Governance Principles and Recommendations with 2010 Amendments (ASX 2010) was released on 30 June 2010 and came into effect on 1 January 2011. It continue to ensure the principles-based framework it developed for corporate governance continues to be a practical guide for listed companies, their investors and the wider Australian community. Although the elements are similar between MCCG 2012 and ASX 2010, there are some distinction between the both in its approach to corporate governance (refer appendix) as discussed below:-
In addition for the roles of chair and chief executive officer to be exercised by different individuals, MCCG 2012 requires that the chairman must be a non-executive member of the board to promote accountability and facilitate division of responsibilities.
MCCG only requires the board to comprise a majority of independent directors when the chairman is not an independent director. ASX 2010 on the other hand recommends an independent majority board regardless whether the chair is an independent or not to ensure board's judgement is independent and to the interest of the company.
While provision for gender diversity in MCCG 2012 is only mentioned in its recommendation commentary, the ASX 2010 stresses the importance of achieving gender diversity in the board and was included as its recommendations. Diversity bring different perspectives to the difficult issues facing today's corporations. It is widely believed that diversity of thought result in better decision making.
Access to information and independent advice
MCCG 2012 only ensures access to information and advice based on board members request is seen to be reactive. Contrarily, ASX 2010 requires the board members to be provided by the company with the information it needs to discharge its responsibility effectively. This is a proactive approach to a better check and balance.
Effectiveness of independent directors
Whilst ASX 2010 did limit the number of years an individual is considered as independent directors, MCCG 2012 specifically mention that a board member should not exceed a cumulative term of nine years. Upon completion of the nine years, an independent director may continue to serve on the board subject to the director's redesignation as a non-independent director. Shareholders' approval for the reappointment is required.
Responsibilities of Nomination Committee
As stated in the commentary for responsibilities of the nomination committee in ASX 2010 where it include review of board succession plans, it suggest that every board need to establish their succession plan as strategies for the firms continuity and to reduce risk.
3.5.7 Performance evaluation of directors
In addition to what that has been mentioned in the code for performance evaluation in Malaysia and Australia, ASX 2010 also encourages companies to disclose the performance evaluation process of the board, its committees, individual directors and senior executives. This will promote transparent and objectivity in the board process.
3.5.8 Composition of nomination committee
MCCG 2012 recommends remuneration committee to consist majority of non-executive directors (combination of independent non-executive or non-independent non-executive) while ASX 2010 suggests it should consist majority of independent directors with the chair is an independent director (effectively it means independent non-executive). ASX 2010 recommendations on composition of nominating committee promote fairness in making decisions.
3.5.9 Composition of audit committee
The requirement to establish an audit committee and its composition was stated in BURSA Malaysia Corporate Governance guide. MCCG 2012 assumes the establishment of audit committee by the board.
3.5.10 Audit committee charter
ASX 2010 require the Audit Committee to have a formal charter while in Malaysia, requirement to establish an audit committee's term of reference was stated in BURSA Malaysia Corporate Governance guide.
3.5.11 Financial reporting
MCCG 2012 recommendation is concerning about the compliance to the accounting standard. However, for ASX2010, it mentions about review the integrity of the company's financial reporting and oversee the independence of the external data.
3.5.12 Internal control
In addition to recommendations on internal control element, ASX 2010 recommends the CEO or CFO to give declaration with regards to sound system of risk management and internal control. The Malaysian code did not elaborate much on the matter unlike in ASX 2010 where explanations were given on the subject.
3.5.13 Quality of information disclosed by the board
A significant difference between both codes is the quality of information disclosed by the company. In MCCG 2012, company may decide what information is considered appropriate for them to disclose. The word appropriate most of the time will be interpreted to the advantage of the company. But the provision in ASX 2010 indicated that disclosure of information is very important. Companies are required to give report on each of the ASX 2010 principle according to the guide of reporting those principles.
3.5.14 Shareholder relations
MCCG 2012 encourages putting substantive resolution to vote by poll while it was not mentioned in ASX 2010 as to how resolutions in general meetings are preferred to be approved either via poll or "show-of-hand".
Chapter 3 provided theoretical framework of corporate governance with its related literature. This chapter also discussed related literature on corporate governance and GLCs. Chapter 4 will presents the research methodology used for this research paper.