Corporate governance has become a popular discussion topic in most developed and developing countries. In simple terms, corporate governance is the process and structure used to control and manage the firm and its activities with an aim to ensure safety, soundness and enhance firm's value. The widely held view that corporate governance determines firm performance and enable the protection of shareholders' interests has led to increasing global attention. However, the way corporate governance is established and organized differs across countries, depending on economic, political and social context. For example, firms in developed countries have dispersed shareholders and operate within stable governance practices. However, firms that operate in developing countries may be affected by political instability resulting in severe economic dislocation and sharp escalation in defense expenditure, which result in a widening fiscal deficit.
To investigate the reasons for the effectiveness of corporate governance in the context of Mauritius, this study will firstly examine literature on the relationship between board structure, corporate reporting and firm performance. It will then examine the accountability to shareholders and other stakeholders through corporate reporting (considering only corporate social responsibility) mechanisms. In order to provide a basis for this investigation the structure of this chapter is organized as follows: Section 1.2 provides an overview of the context of the study; Section 1.3 explains briefly the relationship of corporate governance practices with firm performance; Section 1.4 presents the aims of the study.
1.2 Context of Study
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A system of corporate governance is required to keep a balance between the interests of the outside investors (individuals and institutions), the entrepreneur (and his family) and the management. Moreover, there are other stakeholders, employees, customers, suppliers, banks and society in general whose interests have to be taken into account, as does the sustainability of the business. Thus governance has been an issue in Mauritius and elsewhere for many years. It was only in 2001 that the Finance Minister at that time took the initiative to create a legal and institutional framework that would give in Mauritius, an up to date and efficient system of governance. Consequently, the Committee of Corporate Governance was formed in 2001. National Committee on Corporate Governance (NCCG), the Securities Act, the Insurance Act and the Insolvency Act were passed. In 2001, the Financial Services Commission was set up whose main task was to set up the code of corporate governance in Mauritius which was launched in 2003 which all the Mauritian companies had to comply with.
Even though most countries were faced with the financial crisis in 2008 that caused a fall in their income for most industries, this did not have a major impact on the Mauritian industries in 2010 where some sectors like the tourist industry still experienced an increase in their profits. Was it due to the corporate governance practices that were recently introduced which helped industries to face the crisis? The other chapters namely chapter 5 (analysis) will try to explain whether the introduction of corporate governance had an impact on firm performance.
1.3 Corporate Governance Practices and Firm Performance: The Issues
In order to understand the governance practices referred to in this study, a discussion on the important aspects of corporate governance practices and firm performance is required.
1.3.1 Corporate governance practices
In general, corporate governance is considered as having significant implications for the growth prospects of an economy, because proper corporate governance practices reduce risk for investors, attract investment capital and improve performance of companies (Spanos 2005). Effective corporate governance is considered as ensuring corporate accountability, enhancing the reliability and quality of public financial information, therefore enhancing the integrity and efficiency of capital markets, which in turn will improve investor confidence (Rezaee 2009). Therefore, in order to support what previous researches stated, the main corporate governance mechanisms (board composition, leadership structure, board committees and CSR reporting) will be tested against firm performance measures (Return on Equity, Return on Assets and Tobin's q) so as to identify any relationship between those two.
1.3.2 Firm Performance
Firm performance is affected by corporate governance practices of firms in Mauritius, because their success or failure is dependent on the extent to which they are managed efficiently. Good corporate governance practices enhance firm performance through better management and prudent allocation of firms' resources. Earnings resulting from increased performance, contributes significantly to share prices. Therefore good corporate governance practices can increase the demand for shares as well as increase the price of shares of a company (Mobius 2002).
1.4 Aim of the Study
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The introduction of corporate governance practices in Mauritius had the main objective to provide a mechanism to improve investor confidence and trust in management and promote economic development of the country. Therefore, in order to understand the governance practices that contribute to enhance the value of listed companies in Mauritius, the study aimed to:
Analyse the efficacy of corporate governance practices, which affect firm performance resulting in accountability to shareholder and other stakeholders through appropriate corporate reporting practices, which enhances the value of the firms of listed companies in Mauritius. This research determined relationships between the corporate governance practices of board structures (comprising of leadership, composition and committees) and corporate reporting practices of CSR reporting and firm performance of listed companies in Mauritius.
Therefore this study examines the association between corporate governance practices and firm performance in Mauritius, as a result of the adoption of code of corporate governance in 2003 and the changes that occurred with the compliance corporate governance practices seven years after (2010).The specific objectives of the study are to:
Examine the development of corporate governance practices in the context of the Mauritian business environment;
Investigate the extent to which the companies have adopted corporate governance practices;
To determine whether adoption of code of corporate governance in 2003 has resulted in any changed in the firms' profitability or management.
Analyse the board structures of the listed companies;
Examine corporate reporting practices and the extent of corporate social reporting disclosures among the listed companies;
Determine the relationships between corporate governance practices (such as board leadership structure, composition, and committees), and CSR reporting on firm performance; and
Recommend a corporate governance model with an emphasis on corporate governance practices, including board structure and reporting that results in accountability to all stakeholders.
Chapter 2: Literature Review
2.1 The concept of Corporate Governance:
Corporate governance is not easy to define as a result of the perpetually expanding boundaries of the subject (Roche 2005). Definitions vary according to the context and the cultural situations (Armstrong & Sweeney 2002) and the perspectives of different researchers.
The OECD, Organisation for Economic Co-operation and Development, defined corporate governance as a mechanism which monitors and controls firms. Corporate governance also defines the role as well as the relationship of the management, board, shareholders and the stakeholders of an organisation . Corporate governance also establishes a framework through which the main aims of the firm are defined, and the method these aims will be achieved as well as monitoring firm performance are determined, (OECD 2009). While the conventional definition of corporate governance does acknowledge the fact that 'other stakeholders' are important for the adequate functioning of a corporate entity, most of the debates are focused of the relationship between shareholders and the corporate managers.
In 2001, a broader definition offered by OECD was:
"Corporate governance refers to the private and public institutions, including laws, regulations and accepted business practices, which together govern the relationship, in a market economy, between corporate managers and entrepreneurs (corporate insiders) on one hand, and those who invest resources in corporations, on the other (OECD 2001, p. 13)."
However, the importance of sound corporate governance does not limit itself to shareholders interest being satisfied, consequently a proper definition of corporate governance should not just describe directors' commitments to shareholders since ideas constituting proper corporate governance vary across several nations . Adrian Cadbury defined corporate governance as:
"Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage efficient use of resources and equally to require accountability for the stewardship of the resources. The aim is to align nearly as possible the interest of individuals, corporations and society. The incentive to corporations is to achieve their corporate aims and to attract investment. The incentive for the state is to strengthen their economies and to discourage fraud and mismanagement (Cadbury 2000)."
There are various explanations for the expanding significance of corporate governance. One major reason for this growing interest is due to the several financial scandals associated with governance failure and misconduct. Empirical evidence shows that poor corporate governance structure is related with financial reporting fraud (e.g. Dechow et al. 1996, DSS; Beasley 1996). Corporate governance was set up with a scope to minimize financial frauds such as BCCI, Polly Beck and pensions funds of Maxwell Communications Group in the late 1980s and early 1990s in the UK, controversial executives' pay (like Byrne, Grover and Vogel), and the use of anti takeover strategies and tools by managers. Moreover, corporate firms that promote and implement proper governance are backed by deep and transparent financial markets and efficient resource allocation. This in turn enhance financial and economic stability and boosts growth rates, while firms with weak governance do the opposite.
2.2 Theoretical Perspective of Corporate Governance
2.2.1 Agency Theory:
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Corporate and "principal-agent" or "agency" problem have been associated is numerous debates and studies. This theory was initially mentioned by Berle and Means (1932) in a paper associating separation of ownership in large corporate entities. The principle agent, or also referred as agency problems, is commonly the starting point of most debates on the concept of corporate governance. The interests of stakeholders are not always aligned. Depending on the parties involved in conflicts, agency problems can be categorized as: managerial agency (between stockholders and management); debt agency (between stockholders and bondholders); social agency (between private and public sectors); and political agency (between agents of the public sector and the rest of society or taxpayers).
The basic concept of agency theory is that the managers are motivated is satisfying their own interest, thereby, showing less commitment to safeguard shareholder interests. For example, the managers can be more keen to build luxurious offices, buy company cars and the owners will bear these costs. Moreover, the managers usually possess more technical knowledge, experience and know-how the firm's operations and the market will be in a favorable position to pursue their own goals and desires rather than shareholders (owners) interests (Fama, 1980; Fama & Jensen, 1983).
Jensen and Meckling (1976) show how shareholders/investors had to incur additional costs in order to ensure that managers of the firm are satisfying the formers' interest. They define agency costs as:
"-being the sum of the cost of monitoring management, such as budgeting, auditing, control and compensation systems (the agent); bonding the agent to the principal; and residual losses and it includes . As with any other costs, agency costs will be captured by financial markets and reflected in a company's share prices. Therefore, different internal and external mechanisms have been considered via corporate governance to prevent agency conflicts as well as reducing costs associated with such agency."
Many authors highlight the importance of agency problem when analyzing the role of the boards and other corporate governance features with firm performance (Cadbury, 1992; Vienot, 1995; Hampel, 1998; OECD, 1999; King, 2002)
2.2.2 Stakeholder Theory:
A stakeholder is any group of individuals who are directly or indirectly concern with a firm's operation and can have an impact upon its activities, in achieving the firm's target (Freeman 1984). According to Ansoff (1965), an adequate balance is required when satisfying the stakeholders' interest, conflicting in nature, is vital for a firm to achieve its objectives. Therefore, an important approach of stakeholder theory is to identify the stakeholders an organisation is responsible for. Any stakeholder is relevant if their investment is, in some form, subject to risk from the activities of the organisation (Clarkson 1995).
Main criticism of stakeholder theory is to identify the genuine stakeholders of an organisation. One argument is that meeting stakeholders interests also opens up a path for corruption, as it offers agents the opportunity to divert the wealth away from the shareholders to others (Smallman 2004). But the moral perspective of stakeholder theory is that all stakeholders should benefit from equally rights in a firm, and managers should operate the firm for the welfare of all stakeholders, regardless of whether the stakeholder management enhance financial performance (Deegan 2004).
2.2.3 Stewardship Theory
Although due to effective separation of ownership and control, the agent may be opportunistic, stewardship theory argues that the agents are not necessarily motivated by individual goals, rather they are motivated to work in the interest of their principal (Barney, 1990; Donaldson, 1990; Davis et al, 1997; Donaldson and Davis, 1991). Unlike agency theory, stewardship theory favors CEO duality. This theory imply that the power of the executives and best stewardship role can only be performance when the role of the CEO and Chairperson of the board is combined (Donaldson and Davis, 1991; Ong and Lee, 2000). Another important aspect of stewardship theory suggests that including independent directors on the board is beneficial for improving decision making as well as ensure proper functioning of the firm's operations.
Stewardship theory sees a strong association between managers and the prosperity of the firm, and therefore the stewards protect and maximise shareholder wealth through better firm performance. A steward who improves performance successfully, satisfies most stakeholder groups in an organisation, when these groups have interests that are well served by increasing organisational wealth (Davis, Schoorman & Donaldson 1997).
2.3 Empirical Literature
2.3.1 Board Composition and Firm performance
The board of directors regarded as the most outstanding governance mechanism of the internal control system along with ownership concentration provide a vital monitoring function in dealing with agency problems in the firm between investors and management and between controlling and minority shareholders.
126.96.36.199 Board Composition
Hermalin and Weisbach (1991) provide evidence on board mechanism. In their research in the United States, they used the performance measure Tobin's Q and concluded that low proportion of internal directors compared to outside directors is not related in increasing firm economic performance but are rather effective monitors and a critical disciplining device who aid managers in sound decision making regarding acquisitions, executive compensation and CEO turnover. Further backed by Bhagat and Black (2002) who used the same performance measure and suggested there is too little to assume a cross-sectional relationship between board composition and firm economic performance.
Other Studies in different countries have provided empirical evidence on whether board composition is related to performance on firms. Dahya et al (2002) examined the effectiveness of board following the implementation of the UK Code of best practice by Cadbury Committee. The code required board in UK firms to include at least 3 outside directors and that seat of Chairperson and CEO should be occupied by different individuals. However the code is not mandatory but an explanation should be put forth by firms as to why they are not complying. Dahya et al, 1998 notice that CEO turnover substantially rose and that sensitivity of turnover to performance is stronger after its implementation. They concluded that is the higher proportion of outside directors on the board that explains the turnover.
Another survey conducted by Wymeersch (1998) provided a deep insight on the composition on European board of directors. According to Wymeersch's findings the role of the board of directors in not defined in the law enforced in most European nations. Consequently, shareholders' aim of wealth maximisation was not the principal target of European boards. British, Belgium and Swiss adhered closely to American model while for the other European countries composition of board would vary. European board are most often unitary as in the US. However, some European countries the two-tiered system is the rule. In a two-tiered system, the board consists of a managing board, all executive directors, and supervisory board composed of non-executive directors. The two tiered rule can be mandatory is some nations such Germany and Austria while being optional in countries like France and Finland. In the case of Germany, employees are represented in the supervisory board, a system called co-determination, and it is mandatory for firm with more than 500 employees.
Evidence of the effectiveness of board of directors differs widely across the world. Kaplan and Minton (1994) conducted a study upon the effectiveness of board in the Japanese system, They studied mainly the relationship of the appointment of outside directors to Japanese firms' board and their performance. They noticed an increase of appointment of outside directors in the events of poor stock performance and earnings losses by firms. Kaplan and Minton measured using stock returns, operating performance and sales growth, that firms experienced more stability and marginal increase in their corporate performance.
Rodriguez and Anson (2001) examine how the market reacted to the implementation of the Spanish code of the best practice, Olivencia Code. The code requires 23 recommendations to Spanish firms that aim at improving and strengthening supervisory role of board of directors in Spain. Rodriguez and Anson reported improvement in stock prices to the announcement of compliance however which stipulates a significant restructuring of the board. Firms that operated poorly showed strong reactions to the announcement of the Olivencia Code compliance.
188.8.131.52 Executive Directors
While the board of directors consists of a ratio of non-executive (outside/independent) directors and executive directors (inside), most studies on board of directors are mainly focused on the benefits and drawbacks of outside directors. Consequently, evidence on the importance and beneficial role of executive directors is scarce.
However, both inside directors and independent directors share, more or less, common goals and interests. Like independent directors, whose role will not be discussed in this paper, executive directors do play their role as governance agent safeguarding between the firm and its owner interests and at the same time maintaining the contractual relationship between the firm and the board of directors (Willianmson 1988). Executive directors, often called internal manager, are vital source of information concerning the constraints and opportunities of their respective firm. With regards to their monitoring role, it is expected that executive provide first-hand information to other board members (Boumosleh and Reeb, 2005). Executive are active participants in the firm's business decision making process , unlike outside directors they obviously have access to all vital information that is beneficial for the firm's decision making. The do not only ease decision making process but also are expected to educate independent directors in firm's operations during board meetings. (Fama and Jensen, 1983). Some studies have provided evidence on the beneficial role of executive directors. Vance (1978) carried a research on firm's performance, measured in terms of return of investment and stock appreciation, are significantly influenced by inside directors' technical know-how and managerial experience more than any other participants in the boardroom. A common goal shared by both executive and independent director is to monitor the CEO. Despite being under the supervision of the CEO, inside directors can have indirect control over the latter by channeling sufficient information to independent directors if there is CEO entrenchment. Thus, effective monitoring role from inside directors and reduction of information asymmetries, may promote a sound corporate governance structure which will obviously lead to a better economic performance of the firm.
However, in reality executives are usually considered as less independent parties from the CEO, which may render their role of monitoring less effective in contrast of outside directors. As they are subordinates of the CEO nor they are in a position to monitor or discipline the CEO (Daily & Dalton 1993b). Consequently, a majority of executive director representation on the board does not necessarily mean improvements in firm performance.
Empirical research on the relationship between board composition and firms' performance have is mixed. Having outside directors in the board is believe to be an advantage for the firm. Petra (2005) stated that outside directors plays a vital and beneficial role in decision making with their vast know-how, expertise and contracts. Independent directors who possess wide breath of industrial experience will contribute effectively to board committee as well as provide key strategic vision which will influence positively decision making process. (Ingley and Van der Walt, 2005). Moreover, board consisting of a higher ratio of independent directors compared to inside directors are more likely to replace their CEO if the firm has produced poor performance (Weisbach 1988) and can freely evaluate management's performance and act to remedy in case expectations and targets are not met (Kesner et al, 1986).
Some research has produced evidence of a positive relationship between board composition and firm performance. Eillingson (1996) finds that the association between CEO compensation and firm performance is stronger when a firm's board constitutes of a high proportion of outsiders. Moreover, the appointment of additional directors in the board has been associated to positive abnormal returns (Rosenstein and Waytt, 1990). Lee et al (1992) finds that board constituting of higher ratio of independent directors than insiders is associated to higher returns in contrast to board composed mostly of executive directors. Other studies have suggested a positive link between having more outside directors and higher firm performance (Marr & Rosenstein 1994: Daily and Dalton 1992: McKnight and Mira (2003): Cotter, Shivdasani and Zenner (1997).
However, lack of time and appropriate expertise of outside directors (sahra & pearce 1989) and their fear to challenge difficult decisions made by management (Lorsch & Maclver 1989) does not contribute to corporate performance. In a study of random sample of 200 Fortune 500 firms in 1991, Johnson (1996) finds boards composed of more inside directors are less likely to adopt anti-takeover provisions and golden parachutes than board dominated by independent directos, and this may affect firm performance overall. In addition, in research conducted by Kosnik (1990) is had been observed that greater diversity in outside directors' principal occupations increases the tendency of corporations to use greenmail. Due to information asymmetry, lack or limited access to knowledge about the firm, could negatively affect board performance Abdullah (2004).
184.108.40.206 Board Size:
Board size refers to the number of member constituting the board. Some studies have been in favor of boards composed of fewer members ( Lipton and Lorsch 1992: Jensen 1993: Yermack, 1996). Lipston and Lorsch (1992) suggest that smaller board size firms are less unlikely to face problems of social loafing and free riding than board huge in size which inevitably increases better and effective communication among members, hence avoiding distortion of information, and greater co-ordination. In the same vein, Yermack (1996) and Eisenberg, Sundgren and Wells (1998) provided evidence that of an inverse relationship between board size and firm performance, hence supporting that smaller boards perform better.
However large boards enhance monitoring ability as well as provide better advice (Klein 1998: Coles, Daniel & Naveen, 2008; Brown and Caylor 2004) found a positive relationship between board size and corporate performance and stated that independence of the board is essential for it efficiency. Chaganti et al. (1985) also find that firms with larger boards also maintain better stability in the long run compared to firms with smaller boards which go bankrupt more often than larger ones. Hence, larger board also assist survival of corporations in the long run. Singh and Harianto (1989) found that large boards restrict CEO domination within board, as such avoiding use of golden parachute contracts not of shareholders' interest, therefore leading to a better board performance.
2.3.2 Leadership Structure and Firm Performance.
220.127.116.11 CEO -Chairman Duality
CEO-Duality is considered as a vital board structure mechanism. It simply refer to a situation where the title for both CEO and Chairman of the board of directors is occupied by one individual. However, many commentators have called for prohibition of CEO serving dual titles (Fama & Jensen 1983 and Rechner & Dalton, 1991). Coles & Hesterly (2000) stated that this mechanism widens the power of the CEO at the expense of board members, which gives rise to agency costs and may affect firm perform. Micheal C Jensen (1983) argue that:
"the function of the chairman is to run board meetings and oversee the process of hiring, firing, evaluating and compensating the CEO. Clearly the CEO cannot perform this function apart from his/her personal interest....for the board to be effective, it is important to separate the CEO and Chairman position"
Boards, in which 2 separate individuals serve the title for CEO and Chairman, are regarded as independent since CEO power is significantly diluted, in contrast to duality structure, and increases board ability to perform effectively in its decision making role and strategic planning (Fama and Jensen 1983). Westpal and Khanna (2003) argue that market reaction to poison pill strategies implemented by corporations is significantly more negative for firms consisting for duality system. Poison pill is a defensive tactic used by management with approval from the board of directors to hinder hostile takeover from other corporations.
However some studies have favored the dual structured system. Stoeberl and Sherony (1985) and Anderson and Anthony (1988) argue that CEO duality establishes strong and explicit leadership in formulating and implementing effective strategies. It has also been argued that 2 separate individuals serving CEO and Chairman title may give rise to information sharing costs (Brickley, Coles and Jarrell, 1997), conflicts between both parties and decision making process and execution may become less efficient. Faleye (2007) using Tobin's q also provided evidence that duality system was beneficial for firms operating in a highly competitive market. Donaldson and Davis (1991) report a higher shareholder returns measured by return on equity for firms adopting the duality system. Dahaene De Vuyst and Ooghe (2001) found that a duality structure has substantial impact on the return on asset. This is explained as the chairman acting as CEO will be active in daily operations of the firm and will do his/her best to maintain consistent growth of the firm as well as their personal reputation.
However a number of empirical research were conducted to provide estimates on the performance of the combined title system and little evidence were found on whether separating titles had an impact on firms' performance (James A Brickley, Coles and Gregg A Jarrell, 1997). While Rechner and Dalton (1991) found a positive relationship between separated leadership structure and firm performance, Boyd (1995) found that duality structure actually helps firm performance. Petra (2005) and Yarmack (1996) also provided evidence that firms with non-duality system is highly valued in the market, since it is believe that internal control is strengthened when CEO is monitored by the Chairman.
2.3.3 Board Committees
Committees is an essential mechanism available for board of directors for decision making process (Bacon and Devis, 1973) as well as providing monitoring or oversight function of the boards consisting of the setting up of audit, remuneration and nomination committees. These committees provide better insight of the board operations and hence enhance the accountability of the board (Harison, 1987) as well as encouraging financial accounting disclosure promoting more reporting practice which reduces managerial discretion and increases quality. (Carson, 2002). Due to the various corporate failures that occurred in the late 1980s and 1990s, the Cadbury Committee was set up in May 1991, publishing a report (Cadbury Report 1992), mentioning that 3 committees should form part of the board structure:
audit Committees, Review of financial reporting and internal controls;
nomination Committee, Board appointments and succession planning; and
remuneration Committee, to decide executive directors' pay and policy.
However, it is possible that firms set up committees just to give impression of doing something. For committees to operate effectively it is suggested that it should be constituted of mostly, if not wholly, independent directors, who obviously should possess required expertise and knowledge about the firm's activity and market (Keong 2002) and also information along with professional advice should be readily made available to these committees.
Studies by Lorsch and MacIver (1989), Daily (1994, 1996) and Kesner (1988) explain that most major processes and decisions are originated from a board subcommittee such as audit, remuneration and nomination committees, rather than boards-at-large. These committees enable the boards to cope with the limited time factor and the complexity of information that they need to deal with (Dalton et al. 1998).
Board accountability and better quality financial reporting were seen important as a result of the financial scandals of the 1980s. Nowadays, audit is regarded as a major aspect of corporate governance structure. Consequently, effective audit leads to proper good governance mechanism which enhances firm performance. Indeed, auditors and audit committees play an essential role in controlling financial management of the company so as to improve performance.
Previous studies carried out to determine the association between reliability of information and audit committees suggest mixed results. Organisations having an audit committee are more likely to provide trustworthy information than those which do not. However, Beasley (1996) suggest that despite having an audit committee, information published by firms is not necessarily reliable. However, Petra (2007) show that independent audit committee has a beneficial impact on the quality of financial statements.
Hus am Aldamen, Keith Duncon, Fimone Kelly, Ray MeNamara, Stephen Nagel (2001) analyse the relationship between audit committee operations and firm performance. They firm performance is enhance when firms set up smaller audit committee which adequate experience and financial expertise..
Due to the existence of agency problem, directors would favor estimation of their management compensation on firm performance, for example on net income or market valuation. Previous research how that CEO compensation is reduced when the board monitors the firm decision-making (Boyd 1994). Consequently, remuneration committee allows the boards, which control management decisions, keep CEO compensation under control.
Nomination committees help the board of directors to appoint members for vacant positions available on the board, which will reduce the involvement of board members, as well as nominating the CEO during the nomination process (Petra 2007). Benefits of nomination committees are that they will appoint individuals who will act as advocates of shareholders (Byrd & Hickman 1992)
Studies on board sub-committees and firm performance are mixed. Klein (1998) provided evidence that firm remuneration committee and firm performance was positively linked, however the relationship was not strong. On the other hand, Petra's (2007) in his study on board structures consisted of audit, remuneration and nomination committees has no relationship with earnings informativeness to the stock market performance. Moreover, Weir and Laing et al. (2002) found audit committee structure has no impact on firm performance.
2.3.4 CSR Reporting:
Corporate social responsibility (CSR) is now seen as an integral part of corporate strategy. Nowadays firms face an increasing obligation to publish CSR reports (Day & Woodward 2009). KPMG (2008) accoutns that about three-quarters of Global Fortune 250 companies examined, between the period of 2007 and 2008, have an officially conveyed CSR strategy that constitute of defined aims. Results from the Economic Intelligence Unit's 2007 survey show that almost 30 percent of analyzed direcotrs consider CSR practice as a main priority issue for the firm with further 40 percent fixing it as high priority.
CSR is defined as:
"achieving commercial success in ways that honour ethical values and respect for people, communities and the natural environment (Liyanage 2007, p. 28)."
Thus, the role of CSR reporting to is convey the implications of the firms activities to the society, in achieving their aims (Deegan 2004). It can also be referred to as the process of communicating the environmental and social effects of the economic actions of firms to specific interest parties within society and to society at large (Gray, Owen & Adams 1996).
According to Buhr and Graftstrom (2007), several companies about their CSR activities as a crucial success factor and refer to CSR as a business policy that creates new market opportunities, product differentiation (McWilliams & Siegel, 2001; Waddock & Graves, 1997), competitive advantage, customer satisfaction and avoid government fines (Freedman & Stagliano, 1991; Shane & Spicer, 1983). It also build creates goodwill, ameliorate firms' reputation, reinforce their brand names and also aid firms to motivate employees. They also favor the concept that CSR reporting enhance firms' value and improves performance.
There various methods used for corporate social responsibility. Measurement of corporate social responsibility depends on addressing the stakeholders (Wood & Jones 1995). According to McGuire (1988), corporate social responsibility is measured using three criteria: expert evaluation, content analysis of annual reports and other documents, and performance in monitoring pollution. A study conducted by Rettab et al. (2008) uses financial performance measures, employee commitment and corporate reputation as measures for corporate social responsibility.
Effects of corporate scandal to the society and the importance of stakeholder orientation has raise awareness for firms to act responsibly, to include issues associated with CSR to the decision-making of corporate boards for responsible corporate conduct (Spitzeck 2009). However, Arora and Dharwadkar (2011) argue that, current level of demand for socially responsible investment is lower than the supply of socially responsible investment. As a result effective governance structures will ensure that managers will act in the best interest of the principal, which suggest that effective governance will reduce positive CSR. According to Turnbull (1994), corporate decision-making can increase efficiency through participation of stakeholders. Therefore de Wit et al. (2006) consider that establishment of the necessary governance structures is important to integrate stakeholder concerns.
Empirical evidence on the association between Corporate social responsibility and firm performance shows indecisive outcomes, which are positive, negative or neutral (McWilliams & Siegel 2000). Margolis and Walsh (2001) report 55% these studies identified a positive association between CSR and financial performance, 22% reported no relationship, 18% found mixed relationships and 4% reported a negative relationship. Similar results were reported by Orlitzky et al. (2003). McGuire (1988) and Nelling and Web (2009) did not find any relationship between CSR reporting and stock market performance.
Chapter 3: Research Methodology
The aim of this chapter is to explain the research methodology of the study. Since the main objective of the study was to test whether corporate governance practices have an effect on performance, the design of the methodology emphasized mainly on prior research into these relationships. This chapter describes the method data will be collected, the development of the hypothesis, variables used to test the hypothesis and techniques employed to report the results.
3.1 Research Methodologies
Data can be analysed in two ways namely using qualitative method or quantitative methods. Qualitative methods analse how individual think and react and is directed towards deep understanding of their experiences, motivations and values. However the disadvantage of this method is that it can be too subjective, biased and lacking rigor. The quantitative methodology involves gathering and analyzing data using rigorous measurements and statistical methods of analysis. The advantage of this method is that it can be used to generalize the results from a large population. However, it tends to explain why the factors observed may have happened.
There are two main sources of data namely primary or original data and secondary data. Primary data is collected at source, for e.g., survey, questionnaires and observations. Data that already exists is known as secondary data such as books, published statistics, internal records and annual reports. Considering the fact that evidence needed to test hypothesis in this study is based on annual reports and published reports, secondary sources will be used in this research.
3.2 Sample Selection
The objective of this study was to conduct an investigation on whether corporate governance affects firm performance of listed companies in Mauritius.
The sample was selected from 51 companies listed on the official site of the Stock Exchange Of Mauritius, SEMDEX. They all companies listed on the official market of the Stock Exchange for the period 2011 only. The aim was to compare the extent to which they had adopted corporate governance practices and to see if it has an effect on firm performance during this period. Out of the 51 companies, only 13 companies were being selected mainly due to few resources for the study and they were not in the scope of the study.
3.3 Data collection
The data required for the study included composition of the board (no of non executive directors), board leadership (positions of CEO and chairman), board committees (audit committee) and corporate reporting practices of the firms (CSR reporting). Those information will be extracted from official sites of the companies, annual reports and other relevant reports. Performance data in the study were return on investment (ROE), return on assets (ROA) and Tobin's Q.
3.4 Design of the Variables: Operationalisation and Measurement of Variables
Described below are the variables used to operationalised the hypothesis. They include the corporate governance variables (ownership structure, board composition, board size, leadership structure, audit committees and corporate social responsibility reporting) company performance and moderating variables firm size. The corporate performance of this study was measured using accounting-based measures and market-based measures. ROE and ROA, which are considered as proxies for accounting measures in the study, and indicate the efficiency of generating profits from shareholders equity and the effective use of companies' assets in serving the shareholders economic interests respectively. Tobin's Q, which is a market-based measure will be used to indicate the market perception of the firm's performance (Weir, Laing & McKnight 2002).
In addition to the variables that are used to hypothesize the relationships, a number of variables that are important in determining firm performance in literature are also considered in this study, such as firm size.
Figure 2.1: Variables used to study the corporate governance practices in Mauritius
3.5 Other Variables: Firm Size
Firm size may be related to corporate governance characteristics and may be correlated with firm performance. Firm size can be represented by market capitalization and book values of total assets of the firm.
3.5.1 Market Capitalization
The size of a company measured by market capitalization represents the total value of a company. Market capitalization is a market estimate of the value of a company, based on perceived future prospects, and economic and monetary conditions. It is calculated by multiplying the current price per share by the total number of outstanding shares. Investor confidence is reflected in the market capitalization.
Investment in companies with higher market capitalization has lower risk compared to the firms with lower market capitalizations, because shares of firms with higher market capitalization are more liquid. Alternatively firms with lower market capitalization may be profitable due to a higher growth potential. The risk factor attached to shares of companies with lower market capitalization may be high, even though they have higher financial returns (Rashid 2007). Prior empirical studies find that firm performance is positively related to market capitalization (Yarmack 1996).
3.5.2 Total Assets
As stated previously, firm size can also be measured by the book value of firms' total assets. Previous research has used total assets to represent firm size. Firm size can be related to other governance variables. Pathan et al. (2007) states that a statistically significant correlation was reported for board size and total assets. Keil and Nicholson (2003) found total assets of a company were positively correlated to board size and board composition. Therefore the total assets are considered to have an impact on the variables used in this study.
3.6 Performance Measures
The existing literature on corporate governance practices has used accounting-based performance measures, such as return on equity (ROE) and return on assets (ROA), and market-based measures, such as Tobin's Q, as proxies for firm performance (Abdullah 2004; Bhagat & Black 2002; Daily & Dalton 1993a; Hermalin & Weisbach 1991; Lam & Lee 2008; Yarmack 1996). Firm performance in this study is measured in terms of the profitability and value of a firm. Since we aim to study the impact of corporate governance mechanisms on firm performance, we take the measures widely used for listed companies, namely, ROE, ROA and Tobin's Q, which are also considered in this study as proxies for accounting return and market return.
Tobin's Q is measured using the firm's market value to book value ratio. It is a measure of growth prospects of assets, defined by the future profitability of the assets in relation to their replacement value (Leng 2004). Bhagat and Jefferis (2002), refers to Tobin's Q as the current market value of the company divided by the replacement cost of the assets, which is measured by the book value of the firms assets. Market value is calculated in a different way by different researchers. In their study on Banking Industry, Adam and Mehran (2005) calculate the market value of the firm as the book value of assets minus the book value of equity, plus the market value of equity.
Tobin's Q compares the ratio of a company's market value and the value of a company's assets. If the value of the Tobin's Q is equivalent to 1.0, it indicates that the market value is reflected in the assets of the company. A ratio greater than 1.0 indicates market value is higher than the company's recorded assets. Therefore a higher Tobin's Q encourages companies to invest more capital, because the value of the company is more than the price they paid. This creates more value for shareholders. On the other hand, a Tobin's Q of less than 1.0 indicates that the market value is lower than the assets of the company which suggests that the market may be undervaluing the company.
Tobin's Q is a proxy for how closely the managers and shareholders interests are aligned. Therefore the higher the Q value, the more effective the governance mechanism and the better the market perception of the company. A lower Q values suggests a less effective governance mechanism and greater managerial discretion (Weir, Laing & McKnight 2002). This study employs the methodology used by Adam and Mehran (2005) and Rashid and Islam (2008) to calculate Tobin's Q, which is as follows:
3.6.2 Return on Equity (ROE)
Return on equity measures the rate of return on shareholders' equity. It shows how well the company uses the shareholders investments to generate earnings. This measures the efficiency of generating profits from each dollar of shareholders equity. A higher ratio indicates a higher return. It is expected that there will be a positive relationship between corporate governance, corporate reporting practices and firm performance. ROE is calculated as follows:
3.6.3 Return on Assets (ROA)
Return on assets shows the profitability of the company's assets in generating profits. It indicates the effectiveness of the company's assets in increasing shareholders economic interests (Haniffa & Hudaib 2006). It also shows the efficiency of management in using its asset to generate earnings. ROA is calculated as follows:
Chapter 4: Theoretical Framework and Hypotheses Development
Table 4.1: Conceptual Framework; Corporate Governance practices and Firm Performance
The conceptual framework (Figure 4.1) demonstrate the relationship between the above theoretical structures (explained in Chapter 2) and interactions between the corporate governance components and firm performance that will taken into consideration for this research. Previous studies from various authors suggest that there exist many variables that affect the association between firm performance and corporate governance (refer to Chapter 2, literature review). Internal corporate governance mechanism will consist of board composition, board leadership structure, and role of the audit, remuneration and nomination committees. The variables that shall be considered for the measurement of firm performance will be Return on Equity (ROE), Return on Assets (ROA) and Tobin's Q (TQ).
This research studies the relationship between corporate governance and firm performance. The corporate governance variables consist of Board structure and Corporate Reporting practices. These variables are regarded vital in influencing firm performance. The board structure referred to in this study includes separate leadership and combined leadership (CEO duality) , independent and executive directors (Director Ownership) and finally board committees. Corporate reporting includes financial reporting and CSR reporting.
The variables CEO Duality structure, a higher proportion of independent directors on the board and the existence of board committees are supported by agency theory. CSR reporting in this framework is supported by stakeholder theory. The variables that represent firm performance are Tobin's Q, ROA and ROE.
Tobin's Q is commonly utilised as a substitute for ï¬rm performance when analysing the association between ï¬rm performance and corporate governance, (Yermack,1996; Gompers, Ishii and Metrick, 2003). Share prices are influenced by corporate governance practices and voluntary disclosures, includes CSR reporting, which is reflected in the value of the shares. Better governance increases efficiency and productivity to the organisation, which means resources invested by owners are used more efficiently (Love, 2010). Consequently firms which are better governed are appraised more by investors leading to an increase in share prices, which shows that firm performance are reflected in prices of securities of quoted firms (Deegan 2004). The scope of this study is constrained to establishing the relationship between internal governance mechanisms and firm performance.
4.1 Hypotheses Development
The hypothesis formulated in this research will be tested to examine the impact of corporate governance practices on firm performance in the Mauritian economy based on year 2011 data.
Hypotheses: The hypotheses of the this research are established on the ground that sound governance practices, that is, board structure and corporate reporting, may improve firm performance in Mauritius. The monitoring mechanism of the board composition (H1a), board leadership structure (H1b) and board committee (H1c) is depicted to explore the responsibility of the board towards shareholders through firm performance. Corporate social responsible reporting (H1d) shows the board's duty to other stakeholders and its effect on firm performance.
4.1.1 Board composition and firm performance
The composition of the board in this study describe the ratio of independent to executive directors occupying the seats on the board. The differentiation between the function of executive and independent directors is vital, since the latter brings specific merits and cons already explained in chapter 2, executive directors.
Board composition is regarded as a key corporate governance mechanism that influences firm performance in Mauritius. Best practice recommendations on corporate governance specifies boards to be constituted of a majority of independent, non-executive , directors (ASX Corporate Governance Council 2003, Cadbury 1992, Hampel 1998, OECD 1999). These requirements were also included in the code of corporate governance in Mauritius (NCCG 2004), since investors regard boards consisted of non-executive directors as an important factor of firm performance.
The relationship between board composition and firm performance was examined in chapter 2. According agency theory, independent are considered as the most key factor of the board structure that influences firm performance. Therefore, the conceptual framework considers the importance of non-executive directors in increasing firm performance in the context of Mauritius. In order, to test the above arguments the following hypotheses are suggested:
H0a: Majority of non-executive directors on the board is not related with firm performance.
H1a: A majority of non-executive directors on the board is positively related with firm performance.
4.1.2 Board leadership structure and firm performance
Taking into account, what has been mentioned in the literature review, leadership structure is an important aspect that affects firm's performance, because board leadership structure involves the monitoring of the CEO (Abdullah 2004; Dalton et al. 1998; Donaldson & Davis 1991).
By analysing the various empirical research in prior chapter, it was found that there is a relationship between board leadership structure and firm performance (Abdullah 2004, Rechner and Dalton 1989, Rechner and Dalton 1991). Therefore, according to the agency theory, the conceptual framework suggests that two individuals occupying the position of CEO and Chairman in important in affecting firm performance. To test the validity of this statement in relation to Mauritian context the following hypotheses are formulated:
H0b: Separate leadership structure is not related with firm performance.
H1b: Separate leadership structure is positively related with firm performance.
4.1.3 Board Committees and firm performance
According to the agency theory, the monitoring task performed by board sub-committees is a crucial factor of corporate governance mechanism, taken into consideration in the conceptual framework, and in improving firm performance in the context of Mauritius. To test the validity the above arguments the following hypotheses are suggested.
H0c: Boards committee structures consisted of audit, remuneration and/or nomination committees are not related to firm performance.
H1c: Boards committee structures consisted of audit, remuneration and/or nomination committees are positively related with firm performance.
4.1.4 Corporate Social Responsibility and Firm Performance
Corporate social responsibility reporting (CSR) is regarded as a detrimental aspect of corporate reporting practices in affecting the firms' value in Mauritius, which is explained in the stakeholder theory. Prior studies have suggested a relationship between CSR reporting and firm performance. According to the stakeholder theory, CSR reporting activities of organisations influence the value of firm, which was considered in the conceptual framework in the context of Mauritius. To test the validity of the arguments put forward, the following hypotheses are considered:
H0d: Corporate social responsibility reporting is not related with higher firm performance.
H1d: Corporate social responsibility reporting is positively related with higher firm performance.
Table 4.2: Summary of hypothesis
CHAPTER 5: ANALYSIS
5.1 Spearman' Correlation
Table 1 presents Spearman's correlation for all the relevant variables in the research. It assessed the relationship between corporate governance variables and firm performance variables. For the year 2011, it can be noted that correlations between variables were low, mostly negatively related, however for some a statistically interrelationship could be established.
*. Correlation is significant at the 0.05 level (2-tailed).
**. Correlation is significant at the 0.01 level (2-tailed).
5.1.1 Board Composition structure
Table 4.1 shows that a negative correlation between board composition and performance variables, Tobin's Q, Return on Assets and Return on Equity, as well as Board committee (BC) in the year 2011. However, despite being positively correlated with Market capitalization, leadership structure and total assets, it is deduced that there is no significant relation between board committee and firm performance.
5.1.2 Leadership Structure
More or less, similar results were found for leadership structure. The Spearman's chart shows that there is no relationship between performance variables and leadership structure, TQ, ROE and ROA being negatively correlated. Even if leadership structure is positively correlated with CSR, Board Composition and Board committee, the spearman's analysis suggest that there is no association between leadership structure and firm performance for Mauritian companies in 2011.
5.1.3 Board committees
In contrast to the previous results, it was found that board committee and firm performance is positively correlated since firm performance variables TQ, ROE and ROA were positive as well as other variables, BSIZE, TA and MC, except for CSR and BCOMP. In other words, this means that setting up a well organized audit, remuneration and nomination committee has enhanced firm performance for the listed companies in 2011.
5.1.4 Corporate Social Responsibility
CSR and firm performance variables were negatively correlated for listed companies in year 2011. Despite being positively correlated with other variables, BCOMP and LDS, negative correlation with TQ, ROE, ROA and BC, shows that practicing CSR reporting, by the listed companies in 2011, does not lead to an improvement in firm performance.
5.2 Analysis of Variance Board Composition and Firm Performance
5.2.1 Board Composition and firm performance:
The results showed that there is no significant correlation between the proportion of non-executive directors and firm performance. The analysis of variance has proved this fact with the F-Statistics for Tobin's Q 4.755 (with p=0.341, >0.05), Return on equity 0.852 (with p=0.690, >0.05) and lastly Return on assets 1.872 (with p=0.532, >0.05) for the year 2011. Consequently, we should reject H1a and accept null hypothesis (H0a), which means that there is not enough evidence to prove independent board has any positive impact on improving firm's performance.
ANOVA for Board Composition and Firm Performance
Firm Performance Variable
Corporate Governance Variable
Return on equity (ROE)
Return on assets (ROA)
5.2.2 Leadership Structure and Firm performance:
Analysis of variance was also conducted to determine the relationship between leadership structure and firm performance. The test suggests there is no evidential relationship between separate ownership and firm performance, under any performance measure. According to the ANOVA analysis, F-statistic for Tobin's Q 0.353 (p=0.569, >0.05), ROE 0.014 (p=0.910, >0.05) and ROA 0.241 (p=0.637, >0.05), the null hypothesis (H0b) should be accepted. In other words, there is no correlation between separate leadership system and firm performance.
ANOVA for Leadership Structure and Firm Performance
Firm Performance Variable
Corporate Governance Variable
Return on equity (ROE)
Return on assets (ROA)
5.2.3 Board Committee and Firm Performance:
Results from the variance analysis conducted for board committee and firm performance shows, just like the previous tests, that there is no relationship board committee and firm performance. Since probability for all three performance variables is greater than significance test 5%, H1c must be rejected and H0c accepted. This concludes that setting up audit, nomination and remuneration committee does not improve performance.
Firm Performance Variable
Corporate Governance Variable
Return on Equity (ROE)
Return on assets (ROA)
ANOVA for Board Committee and Firm Performance:
5.2.4 Corporate Social Responsibility and Firm Performance:
Analysis of variance conducted for CSR reporting and firm performance shows that there is no relationship between these two variables. Consequently, null hypothesis (H0d) must be accepted, that is, practicing CSR reporting does not have a significant impact on firm performance in Mauritius for listed companies in year 2011.
ANOVA for Corporate Social Responsibility and Firm Performance
Firm Performance Variable
Corporate Governance Variable
Return on Equity (ROE)
Return on assets (ROA)
5.3 Discussion and Implications of results
This chapter will discuss about the findings, obtained in Chapter 5 from Spearman's correlation and Variance analysis, and what does these results imply when establishing a link between firm performance and corporate governance for listed firms in Mauritius, year 2011. The results of the statistical models in determining the relationship between corporate governance variables, board composition, leadership structure, board committees and CSR, and firm performance are summarized as follows:
H0a: A high proportion of outside directors on the board is not related with firm performance.
H0b: Two individuals holding CEO and chairman position, in a firm, is not related to firm performance.
H0c: Board committees are not linked with firm performance.
H0d: CSR reporting is not related to firm performance
5.3.1 Board composition and firm performance
One of the main aspects of corporate governance mechanism taken into consideration during the research wa