The effect of corporate governance on firms performance and capital structure

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Corporate governance is defined as set of techniques used to manage relationship among stakeholders and to determine and control the strategic direction and performance of organizations according to Crossland and Hambrick (2007). In another word, corporate governance can be meant mechanisms that a corporation uses to construct an order between owners and managers. Since the number of owners, namely shareholders, is considerable in a corporation, they hire agents called managers to control and direct corporation. Managers are expected to run company in a way that increases shareholders' value. Ghosh and Moon (2007) argue that in running of corporation shareholders and their agents (managers) may dissent because their interests are different. Ghoshal and Moran (1996) have defined managerial opportunism as seeking of self-interest with guile. Because of these conflicts, corporate governance is created within each corporation to solve the relevant problems. As Ireland, Hoskisson and Hitt (2009) discuss, in the modern corporate, three internal governance techniques and one external governance technique are practiced. Ownership concentration, the board of directors and executive compensation are internal mechanisms or techniques and market for corporate control is external mechanism. As mentioned, Establishment of board of directors is one of the ways (internal) applied for monitoring managerial decisions by shareholders. The board of directors is a group of individuals elected by shareholders to act in a way that maximize their wealth by controlling and monitoring top-level executives (Bonazzi and Islam, 2007). As a matter of fact, this board is categorized into three groups: insiders, related outsiders and outsiders. Historically, inside managers made up high percentage of board. Many persons believe the boards that high percentage of its members includes inside managers act weakly. In addition to this, some people express that increasing number of outside directors is not enough to settle problems; power of CEO plays an important role in this issue (Lee and Carlson, 2007). Power and independence of outside directors has been increased as a result of separating roles of CEO and chairperson so that separation is also because of previous scandals in board room; therefore, corporate governance has recently become critical due to these scandals. One of the evident examples in relation to this case is Enron Corporation, an American energy company based in Texas, scandal in October 2001 eventually led to bankruptcy. Enron has become as both the biggest audit failure and the largest bankruptcy reorganization in the American history in that time. On the other hand, since outside directors are not aware from day-to-day operations in corporation, they don't access to all of information so it can create some problems especially when corporation has many outside directors (Fich and Shivdasani, 2005). Executive compensation, another internal mechanism, is defined as technique that looks for to balance managers and owners' interest through bonuses, salaries, and long term incentive compensation like stock options according to Rehbein's statement in 2007. Larraza-Kintana et al (2007) express that the use of long-term pay can helps firm to solve potential agency problems through linking wealth of managers and common shareholders.

Market for corporate governance is considered as external governance techniques when internal control of corporate fails as Sinha discussed in 2006. Kini et al (2004) view market for corporate governance as a court of last resort. In this mechanism many firms try to purchase potentially undervalued companies so that they can form new divisions in established diversified companies. This mechanism ensures that managers who are ineffective are disciplined of course when this mechanism operates effectively (Masulis et al, 2007). Many managers and board of directors are very sensitive about hostile takeover bids because they know that this poor performance is product of their weak management; therefore, they know that they would lose their job. Hostile takeovers are major practices in the market for corporate control governance mechanism (Ireland, Hoskisson and Hitt, 2009). The firms targeted for hostile takeovers apply some defense strategies to avert the takeover attempt. Defense strategies include poison pill, corporate charter amendment, golden parachute, litigation, greenmail, standstill agreement, capital structure changes as Pearce and Robinson stated in 2004.

According to Bauer et al (2007), empirical research has indicated that there is remarkable relationship between performance and corporate governance features. Many researchers have focused on specific features of corporate governance. For this reason, it has become difficult to establish an overall relationship between corporate governance and corporate performance. Boehren and Oedegaard (2003) believe that associating corporate performance with a specific aspect of corporate governance may not reflect correct relationship unless that particular aspect is supervised by other aspects. Nelson (2004) has considered CEO characteristics and performance, Carline et al (2007) has studied on corporate mergers as a mechanism in corporate governance and corporate performance and so on; therefore, minority of researchers have focused on overall relationship between performance and corporate governance. Bhagat and Bolton (2008) have claimed to do a comprehensive and econometrically defensible analysis of the relation between corporate governance and performance. According to their claims, they have taken into account endogenous nature of relationship between performance and corporate governance and also relationship among ownership structure, capital structure, performance and corporate governance with use of simultaneous equations framework. Researches on corporate governance also has been take place in many country because many people wanted to see situation of corporate governance and corporate in their country. In Malaysia also some investigations have been done.

In 1997 when Malaysia and other Asian countries faced to financial crisis, corporate governance as an important issue was emerged. The financial crisis represented weak corporate governance practices: the weak financial structure of many companies; over-leveraging by companies; lack of transparency, disclosure and accountability; existence of a complex system of family control companies; little or no effective laws to ensure that controlling shareholders and management treat small investors fairly and equitably; assets shifting; conglomerate structures that were perceived to be given preferential treatment; allegations of cronyism; lack of transparency and ambiguity in the regulatory processes; and weaknesses in the credit evaluation processes by the banks. Weak corporate governance practices by these companies, though did not cause the financial crisis, but certainly contributed to the economic crisis. In 1998 two organizations with names of High Level Finance Committee and the Malaysian Institute of Corporate Governance were formed to train and generate knowledge among Malaysian corporations sectors, public and investors in relation to corporate governance practices. The result of this action was releasing of Malaysian Code on Corporate Governance in March 2000.

A hybrid method between prescriptive and non-prescriptive models has been chosen by The Malaysian Code on Corporate Governance (The Code). The prescriptive model is related to standards of favorite practices for disclosure of compliance in a cast that non-prescriptive model call for disclosure of corporate governance practices. Actually the purpose of the Code is encouraging disclosure by providing enough, relevant and accurate information with individuals that want to invest so that facilitate investment decision being made and to assess performance of the companies. The Code also directs to set out principles and practices on structures and processes that companies can apply them for their operations to achieve optimal governance framework. Composition of board, procedures for recruiting new directors, remuneration of directors, the use of board committees, their mandates and their activities are issues that considered in the Code. The code include four parts: 1- Principles of corporate governance, 2- Best practices in corporate governance, 3- Principles and best practices for other corporate participants and 4- The explanatory notes. Vast principles of good corporate governance practices are related to part one. Arranging of practices in corporate governance in regard to the board of directors, accountability and shareholder is related to part two. Part three recognize the increasing role of auditors and investors in corporate governance. As a matter of fact, third part takes parts in shareholders voting, dialogue between companies and investors and assessment of governance disclosures. Part four provide notes that explain earlier parts. In the next pages laws and regulation of corporate governance in Malaysia will be disscuss.

Corporate Governance in Malaysia:

In 2001, revised listing requirements of Bursa Malaysia offers greater obligation in order to public listed companies to increase Malaysia's corporate governance administrations. (KLSE, Kuala Lumpur Stock Exchange was renamed Bursa Malaysia in April 2004.) The modified Listing Requirements of 2001 draw the requirements for financial reporting disclosure on corporate governance matters and conditioning listing obligations. Malaysian Code on Corporate Governance suggests that the board of directors select compensation and nomination committee.

Organized of other committees such as corporate governance committee and risk management committee are advised too, but these committees are run less frequently by listed firms. The Malaysian Code on Corporate Governance advises the responsibilities separation between board chair and the CEO, although Bursa Malaysia Listing Requirements (2001) does not require the isolation of these situations. Law such as the board of directors must keep a sound structure of inside organize was stated by Malaysian Code on Corporate Governance. Established this principle leads to the issuance by exchange of A Guide on Statement of Internal Control in May 2001. This guide line defines the most important key areas that directors must notice before they issue A statement of Internal Control in their annual reports. Firm that are listed is needed to concentrate on Principle and Best Practices in the Malaysian Code on Corporate Governance in their annual reports. Furthermore, directors who are hired as board of directors of a public listed company are necessitated to ac base on Listing Requirements to attend a director's training program which recognized as the compulsory certification program. Topics of this program cover Companies Act 1965, the listing requirements, internal control, risk management and relevant securities laws. Code on Corporate Governance in Malaysia (2001) provides rules and regulations to restore confidence of investors and to develop standards of corporate accountability.

Act 1965:

All listed companies reveal their extensive shareholders together with their 30 largest shareholders in their annual reports. The Bumiputera shareholding percentage is based on 30 largest shareholders. Hence, a Bumiputera-controlled company is a company in which 50 percent or more of 30 largest shareholdings is held by government and semi-government organizations, Bumiputera individuals, Bumiputera-owned firms, and Bumiputera trust agencies. The same classification process is used to identify non-Bumiputera shareholdings.

Bumiputera in Malaya Language refers to "sons of the soil". It contains Malays, and other native people as separate from Chinese, Indian, and other non-native residents.

Act 2000:

Malaysia has done different reforms in corporate rights and governance regulations. As some examples of these reforms, Capital Market Master Plan by securities commissions in 2001, Financial Sector Master Plan (FSMP) which offered by ministry of Finance in 2001, and recommendations by Finance Committee on Good Governance (FCGG) that are the response to 1997 disasters.

In March 2000, Finance Committee on Corporate Governance, a government-hired team comprising public officials and private participants, offers final outline of Corporate Governance Code of Malaysia. Code was improved by a working group of representatives from the private section, the securities commission and the Kuala Lumpur Stock Exchange, among others.

An Act to revoke the Public Service Tribunal Act 1997, to break up the public service tribunal recognized under the Act and to make available for other subjects linked therewith.(1 January 2000)

In this Act is given some disclosures about transfer of powers, rights a etc:

All powers, rights, opportunities, duties, compulsions and liabilities which immediately before the appointed date were those of the Tribunal shall, as from that date, devolve on the Government.

The Malaysian Code on Corporate Governance is tried to provide guidelines for companies to monitor good corporate governance in their business practices. It was published on Malaysian Law Journal Sdn Bhd on behalf of the Malaysian Institute of Corporate Governance.

The Code will define the principles of corporate governance along with recommended best practices to be applied in the running of a company.


Part 1: Principles:

Broad Principle of good corporate governance is defined in part 1. The objective of the principles is to allow companies to apply these flexibly and with common sense to the varying circumstances of individual companies. Companies are required by the listing requirements of the KLSE to contain in their annual report a description declaration of how they concern the germane codes to their particular events

Part 2: Best practices in corporate governance:

Part 2 sets out best practices for companies. It identifies a set of guidelines or practices intended to assist companies in designing their approach to corporate governance. While acquiescence with best practices is voluntary, companies are required by the listing requirements of the KLSE to state in their annual reports, the extent to which they have complied with the best practices set out in Part 2 and explain any circumstances justifying departure from such best practices.

Part 3: Exhortations to other participants:

This part is designed to address to investors and auditors to enhance their role in corporate governance. These are purely voluntary.

Part 4 - Explanatory notes and "mere best practices":

Part 4 offers explanatory notes to the principles and best practices set out in Parts 1 and 2 and exhortations set out in Part 3. Additionally Part 4 also sets out best practices directed at listed companies that do not require companies to clarify conditions validating, removal from best practices - "mere best practices".


By virtue of paragraph 15.26 of the KLSE Listing Requirements, all listed companies should state in their annual report how they have applied the principles set out in Part 1 of the Code and the extent to which they have complied with the best practices set out in Part 2 and identify and give reasons for any areas of non‑compliance, and where applicable, state the alternative practice(s) adopted.

Sanctions for non‑disclosure:

Where a company fails to disclose the matters set out above in its annual report, it is open to the Exchange to take any action against the listed entity or its directors as set out in the Listing Requirements and section 11 of the Security Industry Act 1983.

Part 1: Principles of Corporate Governance:

A: Directors:

The Board: each listed firm ought to be topped by an successful board which should guide and manage the firm.

Board Balance:

The board should contain a equilibrium of executive directors and non-executive directors (together with independent non­executives). This can lead to that a individual person or small opposition cannot direct and affect board's decision making.

Supply of Information: information that is need for board must be updated. Board should be supplied by timely information. Information have to be accurate and in suitable quality in order to enable it to quality appropriate to enable it to eject its responsibilities.

Appointment to the board: a formal and transparent progress must be in order to make an appointment with new directors to the board.

Re-election: it is necessary for all directors to submit themselves for reelection at reelection at regular space, at least every three years.

B: Directors' compensation:

The level and Make-up of compensation: compensation must be sufficient in order to attract and retain directors to be work as companies interests.

Procedure: Firms must establish a formal and transparent progress for improving rule on executive compensation and for fixing the compensation for individual directors.

Disclosure: inside the firm annual report, it is necessary to contain the compensation o each directors.

C: shareholders:

Conversation among Firms and Investors: Firms and organizational shareholders must be ready, where workable, in order to go into a conversation according to the common accepting of purposes.

AGM: Firms must use the AGM to communicate with classified investors and support their contribution

D: Accountability and Audit:

Financial Reporting: it is one of the board responsibilities to present a balanced, accurate and reliable evaluation of the firm's situation and its futures.

Inner direct: The board must keep a sound structure of internal manage to maintain investors' asset and assets of firm.

Affiliation with the examiners: it is necessary that the board have formal and transparent agreements for keep a good relationship with the firm's auditors.

Part 2: Best Practices in Corporate Governance:

A: The Board of Directors:

Principal Responsibilities of the Board:

Evaluating and approving a Strategic chart for the firm.

supervising the activities of the businesses of company to appraise whether the business progresses are being correctly defined and managed

Recognizing major risks that are faced by company business. In order to make sure that the execution of fitting methods to administer these major risks.

Series scheduling, together with assigning, instructing, securing the reward of and everyplace suitable, substituting senior management.

Improving and executing program related to investor or shareholder interactions rule for the firm.

Evaluating the sufficiency and the truthfulness of firm's management information system, firm's interior control system, and together with systems for conformity with appropriate rules, laws, orders, and guidelines.

Constituting an effective board:

Chairman and Chief Executive Officer

Role of Chairman and CEO should be separated

Where the roles are combined there should be a strong independent element on the board

A decision to combine the roles of Chairman and CEO should be publicly explained

Board Balance

Non‑executive directors should be persons of caliber, credibility and have the necessary skill and experience to bring an independent judgment to bear on the issues of plan, performance and sources contain key scheduled times and standards of conduct

To be effective, independent non‑executive directors need to make up at least one third of the membership of the board

Size of non‑executive participation:

The board should disclose on an annual basis whether one third of the board is independent and in circumstances where the company has a significant shareholder, whether it satisfies the requirement to fairly reflect through board representation, the investment of the minority shareholders in a company

Appointments to the Board:

The board of every company should appoint a committee of directors composed exclusively of non‑executive directors, a majority of whom are independent, with the responsibility for proposing new nominees for the board and for assessing directors on an on‑going basis

Size of Board

each board must check its size, base on a vision to shaping the effect of the number leading its success

Directors' Training

As an integral element of the process of appointing new directors, each company should provide an orientation and education program for new recruits to the board

Board structures and procedures:

The board should gather frequently, with become aware of topics to be argued and should trace its finishes in releasing its responsibilities.

The board should disclose the number of board meetings held a year and the details of attendance of each individual director in respect of meetings held

Relationship of the board to management:

The board, together with the CEO, should develop position descriptions for the board and for the CEO, involving definition of the limits to management's responsibilities

The board should approve, or develop with the CEO, the corporate objectives, which the CEO is responsible for meeting

Quality of Information :

The board should receive information that is not just historical or bottom line oriented but information that goes beyond financial performance and looks at other performance factors such as customer satisfaction, product and service quality, market share, market reaction, environmental performance and so on

Access to Information:

Directors should have access to all information within a company whether as a full board or in their individual capacity, in furtherance of their duties

Access to Advice:

There should be an agreed procedure for directors, whether as a full board or in their individual capacity, in furtherance of their responsibilities to obtain self-governing specialized recommendation at the firm's cost, if needed.

compensation Committees

Boards must assign compensation teams, containing completely or chiefly of non‑executive directors, to advise to the board the compensation of the executive directors in all its shapes, drawing from outside advice as necessary

B: Accountability and Audit:

The audit committee:

The board must set up an audit team of at least three directors, a majority of whom are independent, with written terms of reference which deal clearly with its authority and duties

The Chairman of the audit team must be an self-governing non‑executive director

Duties of the audit committee:

To establish the meeting of the outside auditors, the examination charge and queries of acceptance or firing

To argue with the outside auditors earlier than the audit originates, the character and range of the audit, and make sure co-ordination where more than one audit firm is involved

In order to evaluate periodically and financial statement of end of the year must consider specifically on:

Each modify in rules and regulations of accounting

Significant adjustments arising through the audit

The going anxiety guess

agreement with accounting standards and other lawful necessities

To talk about difficulties and conditions occurring from the temporary and concluding audits, and subjects the auditors possibly will hope to argue (in the nonappearance of management wherever is essential)

To appraisal the management letter from external auditors and response of managements.

To perform the subsequent where an inside audit task be presents

appraisal the sufficiency of the range, occupations and supplies of the inner audit task

analysis the inside audit agenda and consequences of the inside audit procedure and where essential make sure that suitable act is taken on the advices of the internal audit task

evaluation any evaluation or appraisal of the performance of members of the inner audit task

support any meeting or extinction of senior employees members of the inside audit task

notify itself of acceptances of internal audit employees members and supply the resigning employees member an occasion to present his/her reasons for resigning

To consider any related party transactions that possibly will occur inside the firm or team

To consider the major findings of internal examinations and response of managers.

To think about additional subjects this is described by the board.

The audit team must have unambiguous right to look into any issue within its terms of orientation, the capital which it needs to do so and full right to use of information

The committee should be able to gain outside expert recommendation and to request externals with applicable skill to concentrate, if essential

The audit committee should gather frequently, with become aware of subjects to be argued and must trace its results in discharging its duties and responsibilities

B board should disclose in an informative way, information of the actions of audit teams, the quantity of audit gatherings seized in a year and details of attendance of each individual director in respect of meetings

The Board must set up an inner audit gathering.

if an inside audit gathering does not be present, the Board ought to judge whether there are other way of access enough guarantee of usual evaluation and/or assessment of the efficacy of the system of internal controls inside the firm

The internal audit function should be independent of the activities they audit and should be executed with objectivity, skill and due expert concern

C: Shareholders:

The relationship between the board and shareholders:

Boards must maintain an effective communications policy that enables both the board and management to communicate effectively with its shareholders, stakeholders and the public generally

This policy must effectively interpret the operations of the company to the shareholders and must accommodate feedback from shareholders, which should be factored into the company's business decisions

Part 3: Principles and Best Practices for Corporate Participants:

Investors voting: associational investors have duty such as considering about using of their ballots

Conversation among Firms and Shareholders: Institutional shareholders must persuade straight touch with firms together with productive statement with mutually senior managers and members of board about act, corporate governance and other topics influencing investors' attention

Evaluation of Governance Revelations: after estimating firms' governance understandings, particularly those relating to board structure and composition, organizational shareholders and their consultants ought to give suitable power to all related issues drained to their interest

Auditors from outside firm: the outside auditors must separately describe to investors in harmony with legal and expert conditions and separately guarantee the board on the release of its duties base on specialized regulation.

Research Problem

As mentioned in introduction, in 1997 when Malaysia and other Asian countries faced to financial crisis, corporate governance as an important issue was emerged. The financial crisis represented weak corporate governance practices and although weak corporate governance practices by these companies did not cause the financial crisis, certainly contributed to the economic crisis.

Then in March 2000, Malaysian Code on Corporate Governance released as a result of funding of High Level Finance Committee and the Malaysian Institute of Corporate Governance to train and generate knowledge among Malaysian corporations sectors, public and investors in relation to corporate governance practices in 1998. However, observing the effect of these practices on firms need examining the relationship by real data. Therefore, the aim of this research is studying the relationship between corporate governance of Malaysian listed firms and their performance and capital structure.

Research Questions

Is there any significant relationship between corporate governance and performance of Malaysian listed companies?

Is there any significant relationship between corporate governance and capital structure of Malaysian listed companies?

Research Objectives

The objectives of this research are defined as follows:

To examine the effect of corporate governance on performance in Malaysian listed companies.

To examine the effect of corporate governance on capital structure in Malaysian listed companies.