Corporate Governance Practice in Indonesia, Status...
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Corporate Governance Practice in Indonesia, Status Quo? An Empirical Study of the Relationship between Corporate Governance Practice and Performance of Listed Companies Subject : Minor Thesis (Master Business –Accounting) Name : Siti Nuryanah Student ID : 3664255 Supervisor : Prof. Anona Armstrong Prof. Sardar M. N. Islam Victoria Graduate School Faculty of Business and Law Victoria University
Transcript of Corporate Governance Practice in Indonesia, Status...
Corporate Governance Practice in Indonesia, Status Quo?
An Empirical Study of the Relationship between Corporate
Governance Practice and Performance of Listed Companies
Subject : Minor Thesis (Master Business –Accounting)
Name : Siti Nuryanah
Student ID : 3664255
Supervisor : Prof. Anona Armstrong
Prof. Sardar M. N. Islam
Victoria Graduate School
Faculty of Business and Law
Victoria University
DECLARATION STATEMENT
This thesis entitled Corporate Governance Practice in Indonesia, Status Quo? An Empirical
Study of the Relationship between Corporate Governance Practice and Performance of Listed
Companies is the original academic work of the author. It contains no material has been
submitted previously in respect of any other academic award.
Siti Nuryanah
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ABSTRACT
This thesis investigated corporate governance in Indonesia. It assessed the effectiveness of corporate governance in Indonesia by observing listed companies on the Jakarta Stock Exchange (JSX). The evaluation of their effectiveness was based on a survey of the compliance of the listed companies with the Indonesian corporate governance guidelines. In this preliminary investigation, the study found that the implementation of corporate governance in the JSX listed companies is still minimal. This finding is similar to previous study (CGFRC-Standard & Poor’s, 2004) which found that some companies still do not comply with corporate governance regulation. Further, this paper reports the analysis of the relationship between board governance and company performance. Using ordinary least square (OLS), the study finds a relationship between board governance attributes and Tobin’s Q. Specifically, the characteristics of board of commissioners, which are board leadership and composition of board independence, relate positively with Tobin’s Q. A similar result was also shown in the relationship between the independency of the audit committee and Tobin’s Q. In contrast to these three governance attributes, the signs of audit committee characteristics, leadership and accounting/financial literacy, was different with hypotheses. Findings show that the companies which do not have these characteristics have better Tobin’s Q than the companies which comply with the regulations. As reported by the Jakarta Stock Exchange (JSX), there are members of audit committee who still hold double positions, that is similar positions in other companies, thus this might leads inefficient audit committee. Despite the success of the study in confirming all these relationships, this study cannot find an association between size of board governance (both size of board of commissioners and audit committee size) and company performance. Overall, the findings of this study support the proposal that the regulators be stricter in imposing the corporate governance regulations.
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ACKNOWLEDGEMENTS
Finishing this minor thesis, no words can be said but Alhamdulillahirabbil-aalameen,
all praise is due to Allah, the Lord of the Worlds. Next, she is Prof. Anona Armstrong, the
principal supervisor, the first person to whom I want to express my gratitude. I am grateful for
her priceless time; even though she is very busy, she still gives me guidance, supports, and
suggestions. Another person that I want to thank is Prof. Sardar Islam, the co-supervisor. I
believe that I could not finish this thesis without his assistance and his supports. In fact, his
support encourages me to go beyond my initial proposal.
Another person who deserves my gratitude is my husband, Toto Aditama. Without his
support and his understanding, it is impossible for me accomplishing this thesis. In addition, I
want to say thanks to my parents, mama and papa, who always pray for my success and
happiness. I believe I cannot achieve all things that I have without your supports and love.
Finally, to sisters and brothers in Melbourne, thanks for being my good friends. What a
wonderful time I have spent with you all here, in Melbourne!
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TABLE OF CONTENTS
DECLARATION STATEMENT .............................................................................................i
ABSTRACT ..............................................................................................................................ii
ACKNOWLEDGEMENTS ....................................................................................................iii
TABLE OF CONTENTS ........................................................................................................iv
CHAPTER I: INTRODUCTION............................................................................................1
1.1. Background of the Study...................................................................................................1
1.2. Statement of the Problem ..................................................................................................3
1.3. Objectives of the Study .....................................................................................................5
1.4. Significance of the Study ..................................................................................................5
1.5. Overview of the Thesis .....................................................................................................6
CHAPTER II: CORPORATE GOVERNANCE: LITERATURE REVIEW ....................8
2.1. Theory of Corporate Governance......................................................................................8
2.2. Board Governance: Board of Directors and Board Committee ......................................11
2.2.1. Board of Directors .................................................................................................12
2.2.2. Board Committee Structure ...................................................................................22
2.2.3. Measuring the Relationship Between Corporate Governance and Company’s
Performance ...........................................................................................................25
2.3. Conclusion.......................................................................................................................28
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CHAPTER III: THEORETICAL FRAMEWORK ............................................................30
3.1. Research Model...............................................................................................................30
3.2. Research Questions .........................................................................................................36
3.3. Hypotheses ......................................................................................................................38
3.4. Operationalising Key Concepts and Research Instruments ............................................39
CHAPTER IV: RESEARCH METHODOLOGY ..............................................................41
4.1. Available Research Methods...........................................................................................41
4.2. Construction of a Corporate Governance Checklist........................................................41
4.3. Data .................................................................................................................................42
4.4. Research Design..............................................................................................................44
4.5. Empirical Design: Variables and Measurements ............................................................44
4.5.1. Factors influencing corporate governance practice ...............................................44
4.5.1.1. Dependent variables..................................................................................44
4.5.1.2. Independent variables ...............................................................................45
4.5.2. The relationship between corporate governance practice and company
performance ...........................................................................................................47
4.5.2.1. Dependent variables..................................................................................47
4.5.2.2. Independent variables ...............................................................................48
4.5.3. The interrelationship among corporate governance practice, ownership and
company performance............................................................................................50
4.5.3.1. Endogenous variables ...............................................................................50
4.5.3.2. Exogenous variables .................................................................................50
4.6. Statistical Model and Data Analysis ...............................................................................51
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CHAPTER V: RESULTS OF THE STUDY: THE RELATIONSHIP BETWEEN
CORPORATE GOVERNANCE AND COMPANY PERFORMANCE .................56
5.1. Introduction .....................................................................................................................56
5.2. Descriptive Statistics .......................................................................................................56
5.3. Regression Analysis and Tests for OLS Assumptions....................................................59
5.3.1. Regression analysis of preliminary estimated model ............................................59
5.3.2. OLS Classical Assumptions for Preliminary Estimated Model.............................61
5.3.3. Regression analysis of final model ........................................................................65
5.4. Hypothesis Testing..........................................................................................................68
5.5. Summary .........................................................................................................................70
CHAPTER VI: DISCUSSION: IMPLICATIONS FOR INDONESIAN CORPORATE
GOVERNANCE ............................................................................................................71
6.1. Compliance of the JSX Companies with the Corporate Governance Regulation...........71
6.2. The Relationship between Company’s Compliance with Corporate Governance and
Company Performance....................................................................................................72
CHAPTER VII: CONCLUSION AND RECOMMENDATIONS FOR FUTURE
STUDIES........................................................................................................................74
7.1. Development of the Study...............................................................................................74
7.2. Conclusions .....................................................................................................................74
7.3. Limitation and Suggestions for Future Studies...............................................................76
REFERENCES .........................................................................................................................77
Appendix 1: Summary of Literature Review ...........................................................................87
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CHAPTER I
INTRODUCTION
1.1. Background of the Study
The economic crisis which hit Asia, beginning in the middle of 1997, made
Indonesia’s economy plunge into a financial crisis. It is believed that the fundamental fragility
of its economy caused Indonesia and the other crisis-hit countries to experience the problem
(Claessens and Fan, 2002). In addition, the weakness of corporate governance worsened the
condition plunging the country into a prolonged financial crisis (Johnson, Boone, Breach and
Friedman, 2000; Barton, Felton, and Song, 2000). Investigating five hit-crisis countries in
East Asia, Capulong, Edwards, Webb and Zhuang (2000, p. 2) identified that the main reason
of corporate governance weakness in East Asia was because of ‘highly concentrated
ownership structure, excessive government intervention, under-developed capital markets,
and weak legal and regulatory framework for investor protection.’ The highly concentrated
structure of ownership, which is family-based ownership, reduces the effectiveness of
shareholders’ protection. It appears that because the ownership concentration causes an
‘agency’ problem, ‘it may have left the insiders with excessive power to pursue their own
interests at the expense of minority shareholders, creditors, and other stakeholders’
(Capulong, Edwards, Webb and Zhuang 2000, p. 2).
Recognising the culprits, the agency theory of corporate governance provides an apt
solution. The theory (Farrar, 2005) suggests that good corporate governance minimises the
agency problems, then ensures efficient management and, finally, can increase the value of
the company (Shleifer and Vishny, 1997 quoted by Brown and Caylor, 2005a; Van den
Berghe and De Ridder, 1999). Therefore, Capulong, Edwards, Webb, and Zhuang (2000)
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argue that a sound corporate governance system is important so that a conducive business
environment for a corporate sector can be created. This system should protect investors’
interests, minimise systematic risks, and maintain financial stability. Overall, a good corporate
governance policy can increase market confidence and finally boost macro economic
conditions (Nam and Nam, 2005).
To achieve the economic recovery, the Indonesian government has established some
recovery programs, one of which is improving the corporate governance of Indonesian
companies. Initially, the institution namely the National Committee for Corporate Governance
(NCCG) was established. Then in April 2001, the Committee issued a code for practice of
good corporate governance, which is believed to be the best practice for Indonesian
companies. Following the corporate governance improvement programs and to get market
confidence, the Jakarta Stock Exchange (JSX), as one of the Self Regulatory Organisations
(SROs) in Indonesia, also released the decree of JSX’s Director No. Kep-315/BEJ/06/2000.
Specifically, the decree requires the publicly listed companies to have a board governance
structure that includes Independent Commissioners, an Audit Committee, and a Company
Secretary.
Comparing the contents of NCCG’s codes and JSX’s decree, they state the functions
of board governance similarly. The board of directors, which is charged with the daily
management of the company, is under a supervisory of board of commissioners. Therefore,
based on Van den Berghe and De Ridder (1999, p. 59), it can be concluded that the corporate
governance model of an Indonesian company is an example of a two-tier or dual governance
system. There are ‘two individual boards, one responsible for day-to-day policy and
composed exclusively of executives, and a second type of supervisory board which is made
up exclusively of non-active directors’ (Van den Berghe and De Ridder, 1999).
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In spite of the similarity, JSX’s corporate governance principles are stricter than the
NCCG’s code as firstly, the JSX’s regulation is mandatory for publicly listed companies
while NCCG’s codes are voluntary for Indonesian companies (NCCG, 2001; BAPEPAM,
2000; JSX 2000; BAPEPAM 2004). Next, the JSX’s specifically states that at least 30% of
the composition of board commissioners should be independent commissioners (JSX, 2000).
On the other hand, the minimum number of outside members of board commissioners is only
20% under the NCCG’s code (NCCG, 2001). Although the JSX’s code is stricter, the
principles issued by NCCG are more comprehensive as they discuss the issue of shareholders,
the board of commissioners, the board of managing directors, the audit systems, and the
corporate secretary. In contrast, the decree of JSX’s directors contains only the issue of board
governance and does not give thorough information as the NCCG’s code does.
It has been five years since Indonesia, along with the other countries in East Asia
impacted by the economic crisis, began its economic recovery programs in which
strengthening the corporate governance systems is one of the items on the agenda.
Nevertheless, there has been no official evaluation undertaken by the regulators or the
government except for a corporate governance country assessment completed by the World
Bank in 2004. In fact, such evaluating activities are crucial to determine the efficiency and
effectiveness of the regulation. Moreover, it ensures the enlisted companies keep on the right
track of the corporate governance principles.
1.2. Statement of the Problem
Despite the fact that none of the official assessments were initiated by the Indonesian
government, there are a few studies which have reported the implementation of corporate
governance in Indonesia. Firstly, the JSX’s report (2003) indicated that whilst the compulsory
JSX’s corporate governance principles began in the 1st of July 2000, the principles had not
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been effective even by the end of the tolerant period of implementation, the 31st December
2001. Oddly, as the period ended, there were still some companies had not implemented the
requirements (JSX, 2003). Furthermore, the study of Indonesian LQ45 Companies undertaken
by Corporate Governance and Financial Reporting Centre (CGFRC) of NUS Business School,
and Standard & Poor’s (2004) found that in spite of the board governance requirement for
listed companies to disclose the corporate governance practice, a majority of the companies
did not disclose the number of independent directors on the board. The study also identified
that there were some companies, which did not disclose the existence of an audit committee
and some reported that the audit committee was in the process of being formed. Finally, with
regards to macro economic indicators, whilst the theory argues that sound corporate
governance increases market confidence, the market capitalisation of Indonesia remained
small. In fact, compared to the other crisis prone countries, Indonesian market capitalisation
was the smallest; representing only approximately 21% and 26% of the GDP in 2002 and
2003 respectively (World Bank, 2004). In contrast to Indonesia, in 2002, for example, the
percentage of market capitalisation to GDP of the other counties was much higher; 178% for
Malaysia, 165% for Singapore, 44% for Thailand, and 28% for the Philippines (World Bank,
2004).
The evidence above, slow market reaction, indicates that the JSX’s corporate
governance regulation is not effective. The statistics also show that the practice of corporate
governance in Indonesia is still dubious. Furthermore, they indicate a status quo for
Indonesian corporate governance. In fact, there is still a long way to go in the implementation
of successful Indonesian corporate governance. In fact, the determination of the Indonesian
government to implement a sound corporate governance system is crucial so that it can get the
investors’ confidence back.
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Therefore, it is important to find out whether the Indonesian corporate governance
reforms are effective. The term ‘effective’ here has two main meanings, which are firstly,
having five years of corporate governance implementation, whether all the listed companies
has complied with the corporate governance regulation and secondly whether the
implementation of corporate governance amongst these companies relates positively with
companies’ performance as the theory suggests.
1.3. Objectives of the Study
The purpose of the study is to determine the effectiveness of corporate governance
standards in Indonesia by investigating Indonesian publicly listed companies in the Jakarta
Stock Exchange (JSX) as these companies are subject to the corporate governance codes
issued by the JSX. Two kinds of approach were taken in this thesis, namely, a descriptive
study and a relationship analysis. Specifically, the descriptive study determined the
characteristics of the selected companies according to their compliance with corporate
governance principles. Next, under the relationship analysis, the study investigated whether
there is a positive association between the implementation of corporate governance and
corporate performance. Further, in the relationship analysis this study developed a model to
examine the relationship between corporate governance and company performance. In fact,
the model whether a one-way relationship or a two-way relationship (interrelationship)
between the variables needs to be detected further. Therefore, the robustness of the results of
the study can be achieved.
1.4. Significance of the Study
Two main parties interested in the study of Indonesian corporate governance are the
policymakers and the companies. The results of this study can be used by the policymakers to
take further steps related to strengthening corporate governance systems. In addition, the
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findings and suggestions from this study help a company to evaluate and improve its
corporate governance.
This study is useful for both parties as this study differs from the previous research
into the Indonesian corporate governance case. While the prior studies observed only one or
two years of sample, this study takes a longer period to sample, a panel data, which is from
2002-2004. As the effective period for corporate governance practice started from 2002, it is
useful to examine the companies’ response behaviour in response to the corporate governance
regulations from 2002. Hence, by sampling a longer period this study accommodates the time
lag effect of the code for good corporate governance implementation. Therefore, it captures a
better picture of the effectiveness of corporate governance in Indonesia. Finally, the right
statistical model of the study ensures the reliability of the results.
1.5. Overview of the Thesis
The structure of this thesis is as follows. The next chapter reviews the literature
relating to corporate governance. The reviews include the literature which specifically
examines the Indonesian corporate governance experience and the studies which investigate
the relationship between corporate governance and a corporate performance.
Chapter three discusses the theoretical framework of the study. Included in this
chapter are research model, research questions, hypotheses, and operationalisation key
concept and research instruments.
Following chapter three, chapter four discusses the research methodology.
Furthermore, this part describes the literature research, construction of a research instrument,
sampling selection, research design and data analysis.
Next, in chapter five, the research results of the study were presented. Chapter five
contained the details of the descriptive study and the relationship analysis. The best-fit model
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was selected based on a test of the robustness of the findings. However, for the completion of
this minor thesis, only part of the study results, the regression analysis are presented. Further
analysis of the relationships of corporate governance and corporate characteristics will be
pursued in future research.
The final two chapters address the implications of the study, the general purpose of the
study and answers of the study’s research questions. Following this chapter, the conclusion is
presented along with the discussion of the study limitation and the recommendation for future
research of the study.
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CHAPTER II
CORPORATE GOVERNANCE: LITERATURE REVIEW
2.1. Theory of Corporate Governance
The term of ‘Corporate Governance’ had not become a fashionable concept in Asia
until this decade when it was stimulated by the occurrence of Asian financial crisis and the
phenomena of outrageous corporate collapses such as Enron and Worldcom. Nevertheless,
Farinha (2003, p.3) argues that ‘the issues it addresses have been around for much longer, at
least since Berle and Means (1932) and the even earlier Smith (1776)’. Yet, it was the seminal
Cadbury Report 1992 in the UK which became the magna carta of the corporate governance
concept and was the foundation for development of standards or codes of practice. Since then,
many other versions of standards or codes of corporate governance have been developed by
international institutions such as the OECD (Organisation for Economic Co-operation and
Development) and the ADB (Asian Development Bank). Hence, many countries have adopted
corporate governance best practices or have developed their own guidelines, and then
imposed the practice on their economic sectors. Accordingly, corporations around the world
have implemented corporate governance voluntarily or compulsorily. This corporate
governance standards implementation around the world, where there are some countries
follow same version of codes of practice while there are other countries developed their own
code of practice, shows consensus and dissent amongst scholars. Further, this makes the issue
of corporate governance still pertinent to be discussed. These following paragraphs discuss
further the consensus and dissent of corporate governance issue regarding to the definition
and the model of corporate governance while the consensus and dissent related to board
governance and the literature review is presented in other section in this chapter.
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The dissent of corporate governance is started with the issue of its definition. There is
no single definition of the term ‘Corporate Governance. Corporate governance has been
attracting many scholars from various backgrounds, as it is believed that it potentially covers
a large number of distinct economic phenomena (AcadData, 2006). While there is no single
definition of the term ‘Corporate Governance’, Farinha argued (2003) that the substance of
the definition is related to the theory of firm and based upon conflicts of interest between
insiders and outsiders, namely shareholders, corporate managers and debt holders. The
conflict of interests exists as a consequence of the separation of ownership and control in the
company. Therefore, to balance diverging interests, ‘a rule for the game’, namely corporate
governance, is important.
In spite of no single definition of corporate governance, in its narrowest context,
corporate governance refers to ‘a set of arrangements internal to the corporation that define
the relationships between managers and shareholders’ (Iskander and Chamlou 2000, p.6).
‘This set of arrangements refers to control of corporations and to systems of accountability by
those in control’ (Farrar 2005, p.3). Embodying a legal regulation in the centre of the
structure, the control of corporation also includes the system of accountability of the
company, particularly related to the self-regulation system and ‘best practice’ norms (Iskander
and Chamlou 2000; Farrar 2005). Next, in the broad sense, corporate governance includes
‘the entire network of formal and informal relations involving the corporate sector and their
consequences for society in general’ (Keasey, Thompson, and Wright, 1997 in Farrar 2005, p.
6). All in all, it can be concluded that the structure of corporate governance includes
mechanisms both internally and externally.
Turning to the model of corporate governance practice, it is believed that there is no
single model of corporate governance (AcadData, 2006). Shleifer and Vishny (1996, p.750)
argue that this stems from differences in the nature of the legal system of each country around
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the world. In fact, many factors have come together in different ways affecting the legal
systems (Iskander and Chamlou, 2000). Nonetheless, globalisation brings harmonisation.
Hence, currently, there are two corporate governance systems prominently adopted by
developed countries. They are the Anglo-American ‘market-based’ model and the
‘relationship-based’ or ‘Rhineland’ model (Van den Berghe and De Ridder, 1999; Iskander
and Chamlou, 2000; Allen, 2000a).
The first model can be found in countries such as the United States, Canada, and the
United Kingdom whilst examples of the second model can be found in Germany and Japan
(Iskander and Chamlou 2000; Tabalujan 2002). In fact, the corporate governance model
amongst these countries can be differentiated based on essential elements of good corporate
governance systems: legal protection of investors and some form of concentrated ownership.
The legal system in the Unites States, for example, as identified by Shleifer and
Vishny (1996) is an extensive system that does not only accommodate large shareholders’
interests but also protects minority shareholders. Indeed, the system supports ‘active public
participation in the stock market and concentration of ownership through takeovers’ (Shleifer
and Vishny, 1996; p.770). Nonetheless, because of the influence of the American political
system, creditors or banks in this country have relatively fewer rights than they do in
Germany and Japan.
Identifying the legal system in Germany and Japan, Shleifer and Vishny (1996)
differentiate these countries’ legal systems and the United States’. The legal system in
Germany provides more supports for creditors rather than for the other large shareholders, but
no support to small investors to active in the market. Meanwhile, regarding to the protection
for shareholders and creditors, the Japanese governance system is identified as between the
United States and Germany. Japan has powerful banks and long-term shareholders and its
system successfully attracts small investors to participate in the stock market.
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To conclude, because shareholders become permanent large investors whilst stock
market plays important roles, it can be argued that the Anglo-American model focuses on
dispersed controls and free market operation hence it emphasises the primary objective of
company which is the maximisation of shareholders’ value (Van den Berghe and De Ridder,
1999). On the other hand, because the legal system supports long-term investors, more lasting
institutional relationships, the second model is much concern with a socially corrected market
economy where the objective of company is broader than in free market operation, therefore it
emphasises the maximisation of stakeholders’ value (Van den Berghe and De Ridder, 1999).
Comparing to the rest of the world, Shleifer and Vishny (1996) found that the
countries, other than the United States, Germany and Japan, have less substantial legal
protection of investors. Therefore, ‘firms remain family-controlled and … have difficulty
raising outside funds, and finance most of their investment internally’ (Mayer, 1990 quoted by
Shleifer and Vishny, 1996). Indeed, for Asian case, the existence of controlling shareholders
and the regulatory weaknesses become obstacles for the convergence towards the Anglo-
American model (Allen, 2000b). Therefore, ‘it is apparent that many companies (in Asia)
follow more the form rather than substance of corporate governance (of Anglo-American
principles)’ (Allen 2000b, p.26).
2.2. Board Governance: Board of Directors and Board Committee
In the discussion of corporate governance, board governance is the apex of the system.
This is because the effectiveness of corporate governance practice is a function of the board.
Implicitly, the term of ‘board governance’ relates to the board of directors and includes board
committee structures and roles on the board such as corporate secretary (JSX, 2003; Korac-
Kakabadse, Kakabadse & Kouzmin, 2001; NCCG, 2001; JSX, 2000).
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2.2.1. Board of Directors
To begin with, the monitoring activity by the principal has become important since the
separation of ownership and control within the company, thereby to minimise the agency
costs (Jensen and Meckling, 1976). Therefore, a board of directors has a vital role to play in a
corporation, as its responsibility is to manage and direct the management (Farrar 2005, p.69).
Three main characteristics for good board of directors are related to composition, size, and
leadership structure (Van den Berghe and Levrau, 2004). These characteristics which found in
the academics literature are similar to characteristics employed in corporate governance rating
systems.
According to Van den Berghe and Levrau (2004), discussion on board composition
concentrates on the role and the proportion of inside, outside, and independent directors. In
practice, there is a company which its board comprises more outsider than insider but there is
also a company has more insider than outsider. There are six different perspectives that can
explain the difference of board composition among companies. These perspectives, from
which the board roles are derived, are resource dependent theory, agency theory, stakeholder
theory, stewardship theory, institutional theory, and management hegemony theory (Van den
Berghe and Levrau, 2004; Hung, 1998). In his paper, Hung (1998) summarises the six
governing-boards theories that can be seen in the following quotation and depicted in figure
2.1.
“Resource dependency theory assumes that corporations depend upon one another for access to valuable resources and therefore seek to establish links in an attempt to regulate their interdependence... Stakeholder theory believes that there are many groups in society besides owners and employees to whom corporation is responsible; hence, the objective of a corporation should only be achieved by balancing the often conflicting interests of these different groups... Agency theory is concerned with the basic agency structure of two major parties, a principal and an agent, who are engaged in cooperative behaviour, but have divergent interests and attitude toward risk; hence, agency theory is concerned with resolving problems in the contract governing the relationship between the principal and the agent... Stewardship theory, in contrast to agency theory, assumes that managers
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essentially want to do a good job; there is no motivation problem or non-alignment of interest between management and ownership and the governing board will then be mainly responsible for the setting the strategies... Institutional theory assumes that organisations are constrained by social rules, and follow taken-for-granted conventions that shape their form and practice... Managerial hegemony theory refers to a situation when the governing board of organisation serves simply as a ‘rubber stamp’ and all strategic decisions are dominated and pre-empted by the professional managers.” (Hung 1998, pp. 104-108)
Figure 2.1. A Typology of the Theories Relating to Roles of Governing Boards (Hung 1998, p.105)
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Because of the different board perspectives, hence, board composition between
companies or amongst countries might be different; it depends on which theory of board
being adopted. In fact, based on these six theories, six roles of governing boards can be
identified: linking role (from resource dependency theory), coordinating role (from
stakeholder theory produces), control role (from agency theory), strategic role (from
stewardship theory), maintenance role (from institutional theory), and support role (from
managerial hegemony theory) (Hung, 1998). Related to these board theories and derived
board roles, Van den Berghe and Levrau (2004) point out specifically that the agency theory
is countervailing perspective to stewardship theory; while the agency theory recommends the
majority of non-executive directors on the board, the stewardship theory supports a bigger
composition of executive directors.
Despite the diverse perspectives on board composition, it is clear that there is a
requirement for independent directors and non-executive directors as all corporate governance
recommendations around the world suggest these types of directors should be included within
a board. Based on the theory of Berle and Means (1932), it is believed that independent
directors will minimise the cost as it makes the monitoring role and the strategic planning role
of the board more effective (Farrar 2005, p. 364). Nonetheless, empirical studies have had
difficulty in finding evidence which supports this theory. This can be seen for example from
the regression study of Lawrence and Stapledon (1999). Examining the impact of independent
directors on corporate performance and executive remuneration, they could not find either
whether these types of directors affect firm value (both in term of accounting and share-price
measurement) or a relationship between the proportion of independent directors and the level
or pattern of CEO’s remuneration. The similar result of the relationship between independent
boards and firm performance is shown by the study of Abdullah (2004), which takes sample
from Malaysian Listed Companies. Abdullah (2004) assumes that the study failed finding the
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relationship between the variables due to using the financial ratios as a proxy for firm
performance. Compared to company’s growth measurement, which reflects long-term
performance of the firm, the financial ratios might have measured short-term firms’
performance. The positing statement of Abdullah implies that the time lag should be
considered when investigating the relationship between board independence and the
company’s performance.
Support for the belief that independent directors matter for boards still seems difficult
to find even with other methodological approaches. A study by Barnhart and Rosenstein
(1998), examined the sensitivity of simultaneous equations, They found some support for a
curvilinear relation between insider ownership and company’s performance, but weak
evidence for a curvilinear relation between performance and the proportion of outside
directors. Another study, a long horizon study by Bhagat and Black (2002) also confirm no
evidence that companies with bigger numbers of independent directors can perform better
than other companies. Furthermore, this study suggests that the strategy by low-profitability
companies of hiring more independent directors, in order to increase performance, does not
work. Finally, consistent evidence is found by DeAndreas, Azofra, and Lopez (2005). Their
study, combining regression analysis with simultaneous equations, cannot find any clear
relationship between the proportion of outside directors (a proxy for board independence) and
firm value.
Having discussed the board composition as one of elements of good boards, the
second important characteristic for good board of directors is the size of the board. Board size
might influence the dynamics in board functions. As for example, a large and diverse board of
directors may increase the board performance in terms of knowledge and skills. On the other
hand, this type of board potentially may face group dynamics problems, which in turns make
the board less effective (Van den Berghe and Levrau, 2004).
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Hermalin and Weisbach (2003), based on a literature survey, argue that the
relationship between board size and a company’s performance shows consistent results, which
is a negative relationship. Supporting this, the study of DeAndreas, Azofra, and Lopez (2005),
observing the OECD countries about the association between the board size and firm value,
finds a negative relationship between these variables. This negative relationship is persistent
after testing for robustness by controlling the variables board composition, internal
functioning, country effect, industry effect, and market performance measurements.
The statement of Hermalin and Weisbach (2003) above is contradicted by other
studies which find a positive relationship are found in the literature. The meta-analysis of Kiel
and Nicholson (2003) found a positive correlation between board size and market-based
company’s performance (but not for accounting measurement). Similarly, the study of Beiner,
Drobetz, Schmid and Zimmermann (2004), modelling the interrelationships between the
influencing aspects and mechanisms such as leverage and ownership structure, cannot find a
significant association between board size and firm valuation. Then, Kula (2005) also finds no
significant results of the effect of the structure variables, i.e., size, the proportion of
independent directors, and the board committees’ structure, on the firm performance. Finally,
from a banking sample study, Adams and Mehran (2005) also cannot find the relationship
between board size and firm value.
Turning to the third effective board’s factor, the board leadership structure is derived
from two opposition theories namely agency and stewardship theory. According to Van den
Berghe and Levrau (2004), agency theory recommends the separation of the roles of CEO and
chairperson on the board, hence reducing the domination of management on the board. In
contrast, the stewardship theory advocates the unitary structure where a CEO also serves as
the chairperson, to increase the trust and the motivation of the board. Similar to the other
elements of good boards, the vexing results is found in the board leadership structure. The
17
study of Abdullah (2004), which could not find a relationship between the leadership structure
and firm performance, presumed that the reason was the short-term period of measurement in
their study. This unclear relationship is similar to the study of Dalton et al. (1998), which is
quoted by Van den Berghe and Levrau (2004) in their literature review. On the other hand, the
study of Kula (2005) finds a positive impact of separation between chairperson and general
manager on company’s performance. Compared to Abdullah (2004), Kula uses multiple
indicators of firm performance such as indicators of dividends, profits, sales volume and
market share.
Having discussed some elements of effective boards intensively discussed in the
academics literature: composition, size, and leadership, Van den Berghe and Levrau (2004)
report some other elements of a good board of directors. These additional elements of good
boards are based on interviews with 60 directors of Belgian listed companies. From a boards’
point of views, one of the most important elements of a good board is the quality of board
meetings. This was followed by board composition and operation of board of directors as a
decision-making group. Two other criteria less frequently considered under directors’
perspective are the role of board of directors, and the relationship amongst board,
management, and shareholders.
The first element of a good board from a board’s perspective was the quality of board
meetings (Van den Berghe and Levrau, 2004). It relates to the ‘raw materials’ of the meetings,
which are information and the people themselves. Information can be explained by the degree
to which the directors are well informed and well prepared. To be well informed and well
prepared, the willingness of the directors to do continuous study is crucial. However, the
learning process about the company’s business should occur not only in the meetings but also
outside the meetings. In addition to well-informed and well-prepared board members, the
quality of the meetings themselves is important for good meetings. To create high quality of
18
meetings, the members of the board have to be critical, neutral, and objective, and at the same
time preserve a comfortable and constructive climate. In this case, the role of the chairperson
is also important to create good meetings. The chairperson must be a strong leader so that
he/she can drive the board. He/she has to monitor the presence and preparation of the other
members. The way of making decisions, which are neutral from management or shareholders,
well-thought and resulted from depth discussions, also contributes to the effective board’s
meetings. Finally, the participation and involvement of all board’s members ensure the
creation of high quality board meetings.
The issues in board composition from a boards’ perspective are similar to those in
academics’ discussions and corporate governance rating systems; they relate to insider,
outsider, and independent directors. However, under board perspective, the issue of diversity
and complementary of the board is also concerned. There is a belief that diversity gives
competitive advantage and positive perspectives to the board (Burke, 1994 in Hyland and
Marcellino, 2002 and Campbell 1996 in Carter, Simkins and Simpson, 2003). Following this
view, Van den Berghe and Levrau (2004) argue that, to be effective, the board should consist
of different personalities and backgrounds, including educational, occupational, and
functional backgrounds. In addition to these, some years experience of directing companies
and knowledge at least in accountancy, law, and industry are important. Whereas, whether the
board should include of foreign directors depends on the business environment. The empirical
studies related to this issue found that diversity adds value (Carter, Simkins and Simpson,
2003). The diversity, which is identified as including representative of gender and minority
group of society in the composition of the board, is attested to improve the company’s
financial performance. Regarding to the organisation concern on diversity issue, the regional
study of Hyland and Marcellino (2002) found there is a positive relationship between
organisation size and women representation on the board. Supporting this, Carter, Simkins
19
and Simpson (2003) find the diversity increases alongside the size of company but decreases
with an increase of insider directors.
The third element of a good board under directors’ perspective, relates to the nature of
board itself as a decision-making group. Van den Berghe and Levrau (2004) explain that as a
group, the members need to work as a team. Moreover, it is necessary that every member has
moral principles and values, and pursue a group’s common vision and interests. Finally, trust
and a sense of humour and informal meetings outside formal meetings might increase the
quality of board as a decision-making group.
The next element contributing to creating an effective board is a good understanding
of the company’s strategy as well as its business environment. Van den Berghe and Levrau
(2004) report that, based on directors’ views, this knowledge is important so that a board can
perform their strategic and oversight role effectively. Finally, an effective board must keep a
good relationship with both shareholders and management. Therefore, a conducive-working
environment where every part of the company can carry out their job effectively should be
constructed.
Having discussed the theory and presented the empirical evidence, one question that
should be examined further is why the results are inconclusive. This thesis suggests that the
inconclusive results show persistence in a gap between theory and reality. Hence, it is
attractive to be investigated. Nonetheless, two following arguments should be considered. The
first is the endogenous problem amongst the variables (Hermalin and Weisbach 2003, p.8).
Therefore, rather than investigating the effectiveness of corporate governance implementation
by positing one-way relationship, there is possibility of interdependency amongst the
variables (Bhagat and Jefferies Jr, 2002). Accordingly, as the firm performance is a product
from continuous activity of the firm, from previous periods to current years, one year or a
short horizon observation might cause difficulty in interpreting the results. The second
20
argument is that there is a lack of an `integrative’ model in the study. It is the ‘partial’
approach of corporate governance measurement; ignoring the ‘soft’ criteria, causing vexing
results (Zahra and Pearce II, 1989; Korac-kakabadse, Kakabadse, and Kouzmin, 2001; Wan
and Ong, 2005).
Accommodating the integrative model, a study by Kula (2005), designed to find the
characteristics of effective boards, explores not only the issue of the structure of boards but
also the roles and process of corporate boards. In addition, rather than focusing on one
performance measurement, the research employed multiple indicators. This study, exploring
the control roles, finds a positive link between a board role variable, resource acquisition, and
performance but no significant result for board service role and performance. The study also
finds a positive relationship between the variables of board process, namely board
effectiveness and information access, and firm performance. Finally, even though this study
attempts to broaden the investigation by including role and process of a board, Kula (2005)
does not accommodate the endogenous issue of factors influencing corporate performance.
Another study which also used an integrative model was done by Wan and Ong
(2005). They explored the issue through another perspective, which rather than focusing on
‘one-to-one effect’ of board structure on firm value, proposed an indirect relationship between
these variables. Indeed, they start at the point of investigating the direct relationship between
board structure and board processes, then the processes and board performance. Their study
concludes that board structure is not the determinant of performance but the board process.
Despite the similarity of this study to others that identify the structure as board leadership
structure and the representation of outside directors, it differs in that this study takes ‘soft’
elements into the concept namely effort, conflict, and the presence and use of various skills.
Then, whilst financial or accounting measures are constructed to represent performance,
21
measures of the effectiveness of board role indicator and a transparency index are also
introduced.
A prior integrative study conducted by Zahra and Pearce II (1989) proposed a “model
of boards’ attributes and roles.” This model was developed by comparing the four diverse
perspectives on the roles of corporate boards, which are a legalistic perspective, a resource
dependence perspective, a class hegemony perspective, and an agency theory perspective.
These perspectives show different linkage between boards and company performance. The
model introduces specific relationships amongst four board attributes and three vital board
roles. The attributes, identified as building blocks of the model, consist of composition,
characteristics, structure and process, while the roles are specified as the board function in
service, strategy and control. In addition to the attributes, Zahra and Pearce II (1989)
emphasis three important features of the model. The first feature is a contingent nature the
relationship of board variables (attributes and roles) and company performance as they are
influenced by the internal variables, such as company size and CEO style, and external
factors, i.e., environment, industry, and regulation. In the next feature, the model leads to a
specific series of relationship amongst variables, depending on theoretical orientation of the
scholar. The final feature, the multiple character of company performance, will be recognised
consequently. The study not only focuses on short-term measurement but also measures
systemic and social indicators. Therefore, putting the whole factors in the model, the study
tries to get the real picture of the relationship between corporate governance and company’s
performance.
Supporting the integrative model, Korac-kakabadse, Kakabadse, and Kouzmin (2001,
p. 24) state ‘these kind integrative studies provide inclusive results, suggesting the corporate
governance has, at least, an indirect effect on company performance.’ Similarly, Van den
Berghe and Levrau (2004) suggest that in evaluating the corporate board, better insight should
22
be considered. It means the evaluation tools should also cover the intangible elements
influencing the board such as ‘style of meeting’ and ‘style of debate’.
2.2.2. Board Committee Structure
A board committee is established to assist the board of directors. Amongst the types of
board committees, audit committees are set up to help the oversight function of the board of
directors in order to increase financial disclosure. Indeed, financial disclosure becomes a
matter related to the phenomena of corporate collapse (Clarke, Dean, & Oliver, 2003;
Commonwealth of Australia, 2002). In the case of Asian, and following the Asian crisis, the
effectiveness of audit committee is being questioned; thus there is a great concern in the audit
committee (Allen, 2000b). In fact, the phenomena of corporate collapse around the world has
led to legislation or regulation reforms in both the accounting field and in the stock exchange
(Clarke, Dean, & Oliver, 2003; Commonwealth of Australia, 2000b; Allen, 2000). In the 20th
century; following the biggest American corporate scandals: Enron and Worldcom, the
Sarbanes-Oxley Act becomes the magna carta of corporate disclosure, especially in relation
to the audit committee issue (Findlaw, 2005; EIRIS, 2005).
However, previous recommendations were suggested by the Blue Ribbon Committee
(BRC) in order to improve the effectiveness of a Corporate Audit Committee. BRC (1999,
pp.10-15) recommends three important points which should be strengthened are
independence, effectiveness, and accountability. To increase audit committee independence,
BRC defines the meaning and the circumstances so that independence can be assured. Then,
to increase audit committee effectiveness, the issues considered important are financial
literacy, the needs for a formal written charter and its review and assessment, and the
disclosure of a formal written charter adoption in the company’s proxy statement. Finally, for
accountability, BRC recommends some mechanisms of relationship amongst the audit
committee, the outside auditors, and management. Regarding to the mechanisms between the
23
audit committee and the external auditor, BRC suggests that two things, which influencing the
objectivity and the independence of the auditor, must be specified. These are the ultimate
accountability of outside auditor to both board of directors and the audit committee, and the
relationship between the auditor and the company. Then, to increase the accountability, the
letter from the audit committee must be disclosed. The letter contains information of firstly,
the review activity of management to the audited financial statements, secondly the discussion
between the external auditor and the audit committee about the auditor’s judgement regarding
to a quality matter of the accounting principles.
In addition to the recommendations, the report of BRC also addresses ‘guiding
principles for Audit Committee Best Practices’ (BRC 1999, pp.37-44). The guiding principles
relate to the issue of independence, diligent and knowledge of the audit committee member.
Indeed, the principles can improve the key role of audit committee in the context of a ‘three-
legged-stool’ relationship, which is relationship between board of directors (including the
audit committee), financial management (including the internal auditors), and the external
auditors.
Akin to the best practice suggested by BRC, DeZoort et.al (2002) consider four
determinants of Audit Committee Effectiveness (ACE) namely composition, authority,
resources, and diligence. Regarding to the composition, the issues are similar to the BRC’s
recommendations that audit committee should be independence, financially literate, have
integrity and objectivity. Similar to BRC’s recommendation, diligence is defined as the
willingness of committee members working as a team in the context of a ‘three-legged-stool’
relationship. However, related to the resource component of ACE, DeZoort et.al (2002)
emphasis the size of the committee and the circumstances so that ACE can be achieved. The
size, between three and six members under BRC report, is considered suitable. Finally, all
24
criteria will interdependent as for example they will ensure fulfilment of the audit
committee’s authority or responsibilities.
Unlike the issue of board of directors, which heretofore stimulated studies to solve the
agency problem, the issue of board committee has heightened since the current phenomena of
corporate collapses. The ineffectiveness of audit committees has become one of the
problems. DeZoort et.al (2002) in addressing the financial fraud scandals, stated that the
function of audit committees needs to be improved are related to their independence,
composition, expertise, disclosure of activities, discussion of financial reporting quality, and
materiality assessment.
Independence is one of the most important variables in the audit committee
composition, as the literature shows that the independence has a favourable impact on the
audit function. Abbott, Park, and Parker (2000) find that firms, composed of independent
directors in their audit committee and where the audit committee meets at least twice per year,
are less likely associated to both fraudulent and engage in misleading reporting. Next, Xie,
Davidson III, and DaDalt, (2003) find there is small possibility that earnings management
occurs when the audit committee consists of more independent than outside directors. In
addition, Mangena and Pike (2005) find that the companies are more likely to disclose less
interim information when audit committee is less independent. Similarly, the study of
Khrisnan (2005) suggests that independent audit committee decreases the incidence of
internal control problems.
Regarding other criteria for effective audit committee, the literature shows that
experience, knowledge and ability also add value to committee audit effectiveness. In
particular, these criteria enhance the interim disclosure (Mangena and Pike, 2005). In addition
to increase the effectiveness, DeZoort and Salterio (2001) find that, in the case of auditor-
management disputes, the independent members of audit committee and the members’
25
auditing knowledge were positively associated with support for the auditor. Therefore, the
financial disclosure will be more reliable. In the case of aggressive accounting activities, the
literature suggests that an audit committee having more expertise and knowledge in financial
literacy is more effective in constraining the earnings management (Bedard, Chtourou and
Courteau, 2004; Xie, Davidson III, and DaDalt, 2003).
In addition the appointment of directors with financial expertise to the audit committee
is also significantly and positively rated by the market (DeFond, Hann, and Hu, 2005;
Davidson III, Xie and Xu, 2004). DeFond, Hann, and Hu (2005) emphasis that the reaction,
measured by cumulative abnormal returns (CARs), is only positive when the appointed
outside director is independent and when the appointing companies have relatively strong
corporate governance records before the appointing process. Regarding financial expertise,
Davidson III, Xie and Xu (2004) find further that the auditing and audit firm experience is
more important than corporate financial management and financial statement analysis
experience.
Finally, the survey of Rezaee, Oibe, and Minmier (2003) on audit committee
disclosures by Fortune 100 companies shows that the listed companies in the US comply with
the self-regulatory requirements issued by the stock exchanges. Despite the fact that the
process of fulfilling their oversight function should be the major issue in the audit committee
reports, this survey found that the main focus in reports were audit committee roles and
structure.
2.2.3. Measuring the Relationship Between Corporate Governance and Company’s
Performance
Having discussed the specific variable of board governance: board of directors and
audit committee, these following paragraphs present literature on the effect of the corporate
governance practice as a whole on company’s performance. The evidence shows a positive
26
relationship between corporate governance and company’s performance (Black, Jang, and
Kim, 2006; Brown and Caylor, 2005a; Beiner, Drobetz, Schmid, and Zimmerman, 2004;
Gompers, Ishii, Metrick, 2003).
In many of these studies, corporate governance has been measured by governance
indices or governance scores, reflecting all the corporate governance variables as suggested
by regulation or developed by scholars. Further, company’s performance has been valued by
such measures as Tobin’s Q, ROA, ROE, sales growth, profit margin.
Similarly, the global investor survey of McKinsey study (2002) suggests ‘a majority of
investors are prepared to pay a premium for companies exhibiting high governance
standards.’ The premium for these companies are ranging from 12% to over 30%, as the
lowest percentage of premium will be given by Northern American investors while the
highest percentage will be offered by Eastern Europe and Africa.
In contrast to the findings of the favourable effect of corporate governance practice on
the market, an Indonesian regional study of corporate governance, when using Tobin’s Q as
the proxy, cannot find a positive relationship but, with a measure of a company’s operating
performance namely ROE, it does show an evidence of a positive relationship between ROE
and corporate governance (Darmawati, Khomsiyah, and Rahayu, 2004). An explanation for
the Indonesian case, may not be that the market does not respond to the practice, but that, if
there is a response, the response might take time. In other words, there might be a time lag for
the Indonesian market to respond to corporate governance implemented by companies.
Besides this time lag assumption, another explanation might be that endogenous variables
which were not accommodated by this prior study, caused the finding of no supporting results
in favour of a relationship between corporate governance and company performance.
27
Having recognised that corporate governance positively relates to company
performance, the next question is: what factors drive a company to implement corporate
governance principles so that it increases its performance? The literature shows internal
factors and external condition determine the corporate governance structure. The studies of
Adams and Mehran (2003) and Gillan, Hartzell and Starks (2003), for example, find that one
of the factors to affect the structure of the company’s corporate governance is investment
opportunity. Specifically, the study of Adams and Mehran (2003), comparing the corporate
governance structure in bank holding companies (BHC) and manufacturing firms, supports
the view that governance structure is industry specified. Indeed, analysing the causes of the
different governance structure, the main reasons are the dissimilarity in the investment
opportunities and the regulation between these industries. The differences can be seen further,
as firstly, on average, BHC board size and the percentage of its outside directors are
significantly larger than the manufacturing firms. Secondly, BHC boards, on average, have
more committees and meetings than the manufacturing firms. Next, the ratio of stock option
of the BHC’s chief executives to salary plus bonuses is smaller than in the manufacturing
firms. Fourthly, the BHC chief executives have smaller direct equity holdings than the
manufacturing firms’ CEO. Finally, in the ownership structure, the ownership of institutional
holder is fewer in BHC than in manufacturing companies.
Similarly, the study taken by Gillan, Hartzell, and Starks (2003), investigating a
broader sample of companies from more various industries, finds that industry factors have an
important role in explaining the index of total governance in corporate governance ranking
systems. The factors, namely industry investment opportunities, product uniqueness,
competitive and information environments, and average leverage, are pre-eminent variables in
explaining the overall governance structure. In fact, they are more powerful than time effects
and firm factors.
28
Despite the fact that investment opportunity becomes one of the factors influencing
the corporate governance structure, Klapper and Love (2004) find that legal systems matter
for the good corporate governance. Their study suggests that in the environment where
shareholder protection and judicial efficiency is weak, improving the quality of corporate
governance will be important as it may increase the company’s performance and valuation.
Apart from the discussion that investment opportunity is the main factor explaining
the corporate governance practice, some studies show that the other factors, such as bad
financial conditions or ownership structure, influence a company’s corporate governance but
with inconsistent conclusions. As for example, examining the relationship between
company’s performance and the proportion of independent directors, Hermalin and Weisbach
(1988) report that the proportion of independent directors increases as firms experiencing
financial trouble. Nonetheless, Evans, Evans, and Loh (2002) cannot find this such evidence.
They find that the reactions of firms experiencing declining performance are not by changing
the ownership structure, the proportion of outside directors, or CEO pay levels, but by
significantly increasing the board meeting frequency. Finally, whether ownership explains the
corporate governance practice, the study of Barnhart and Rosenstein (1998), examining the
sensitivity of simultaneous equations techniques in corporate governance research, finds a
greater effect of managerial ownership on board composition than vice versa.
2.3. Conclusion
To sum up, this chapter has discussed specifically the board governance issue and also
the association between overall corporate governance practice and company performance. In
the board governance section, attributes related to composition, size, leadership structure, and
board meeting are believed to increase the quality of the board. Similarly, in the board
committee section, the characteristics related to composition, effectiveness, and size are
considered to add to the quality of the board, besides another attribute: accountability. In the
29
final discussion, the literature suggests a positive relationship between overall corporate
governance practice and company performance. The chapter also identifies some external and
internal factors that influence the corporate governance practice of a company.
It is interesting to note that the empirical evidence on the issue above shows
contradictory results. Two limitations are identified: an endogenous problem and the lack of
an ‘integrative’ model. An endogenous problem in the relationship between corporate
governance practice and company performance can be explained further that there might be
interrelationship or two way-relationships between these variables. Therefore, the results of
investigation based on one-way relationship between these variables could be misleading.
There are some econometrics procedures to detect this endogenous problem. While
endogenous problem identified, simultaneous equation model shall be applied to investigate
this kind relationship. Next, related to an ‘integrative’ model, this term refers to the model of
Zahra and Pearce II (1989) and other model that accommodates soft elements of corporate
governance.
This paper has recognised two limitations of previous research, however, this paper
does not attempt to overcome the problems due to the time and data constraints. For
completion of minor thesis, this paper only reports the preliminary examination using
Ordinary Least Squares (OLS). The detection of endogenous problem in the relationship
model will be reported in another paper in the future. Nonetheless, the theoretical framework
of this thesis accommodate the issue of interrelationship problem between variables.
Above all, this paper believes that the preliminary results of the model using OLS give
insight into the corporate governance practice in the Indonesian context. It also provides
guidance for further research into the Indonesian case.
30
CHAPTER III
THEORETICAL FRAMEWORK
3.1. Research Model
The primary objective of this study is to investigate the effectiveness of corporate
governance in Indonesian listed companies. Since corporate governance practice is
compulsory for the JSX listed companies, effectiveness is defined by the compliance of
companies with the corporate governance principles of the Jakarta Stock Exchange (JSX)
rules for corporate governance. In addition to this definition, the theory described in chapter
two suggests that good corporate governance minimises the agency problems, then ensures
efficient management, and can increase the value of the company. Therefore, effectiveness is
also defined as an increase of company performance (Shleifer and Vishny, 1997 quoted by
Brown and Caylor, 2005a; Van den Berghe and De Ridder, 1999).
This study delineates the corporate governance principles based on the JSX decree on
corporate governance (JSX, 2003) and code of corporate governance issued by NCCG (2001).
In fact, the principles focus on the issue of board governance only. In regard to the attributes
of board governance discussed in the literature review, the corporate governance practice in
this paper is specified by the following characteristics:
1. The Board of Commissioner Characteristics:
a. The board size.
b. The proportion of independent commissioners in the composition of a board
2. The Audit Committee Characteristics.
a. The audit committee size.
31
b. The proportion of independent commissioners in the composition of the audit
committee.
c. Board leadership structure.
1). The chairperson is an independent commissioner.
2). The chairperson is not an independent commissioner.
d. Number of member who hold financial or accounting qualifications.
To investigate the first definition of effectiveness, the question is: to what extent are
JSX listed companies compliant with the JSX corporate governance requirements? In
addition, it is also interesting to examine what factors drive the companies to comply with the
regulation.
The literature suggests that corporate governance practice can be influenced by
external factors and internal factors (Iskander and Chamlou, 2000). The external factors
affecting the practice are investment opportunity, type of industry, information and
environment while the internal factors are size of the company, bad financial conditions,
leverage, product uniqueness and ownership structure (Adams and Mehran, 2003; Gillan,
Hartzell and Starks 2003; Hermalin and Weisbach, 1988; Barnhart and Rosenstein, 1998).
In addition to the external and internal factors suggested by the literature, this paper
investigates two additional factors which may influence the companies to implement
corporate governance principles. These factors are: length of tenure of the company listing
and dual listing of a company in overseas international capital markets (e.g. listed in the
United States’ capital market). This study attempts to confirm the results of previous research,
(for example the study of Black, Jang and Kim, 2006), by testing the influence of the length
of listing period on the stock exchange. The reason for inclusion of a dual listing variable is
that companies in Asian countries, which implement an impressive corporate governance
32
practice, are identified as the companies which are listed in other recognised international
capital market Allen, such as in the United States (2000b, p.28).
Overall, the first theoretical framework, which is suggested by this thesis, is depicted
in figure 3.1. The factors influencing the corporate governance practice such as the structure
of board governance or the implementation of code of corporate governance principles are
summarised in the left box. Seven factors are investigated to seek whether these factors are
significant in explaining the differences of corporate governance practices. These factors are
size of company, type of industry, leverage, ownership structure, previous company
performance, dual listing, and length of period listing of a company in the JSX.
Turning to the second definition of effectiveness, this paper attempts to identify the
relationship between corporate governance and company performance. This thesis
investigates the relationship using an OLS method. Next, the analysis which tests whether
there is an endogenous problem between these variables will be conducted in the future.
Therefore, for the next research, whether corporate governance and company performance are
Figure 3.1: Factors Influencing Corporate Governance Practice in Indonesia
External/Internal Factors:
1. Size of company 2. Type of industry 3. Leverage 4. Ownership structure:
Institutional ownership-unrelated
5. Previous company performance
6. Listing in other recognised stock market in overseas
7. Tenure of listing
Corporate Governance Practice
33
interrelated shall be investigated. If there is this kind of relationship, to prevent spurious
regression results, a statistical model of the relationship in a simultaneous equation was
performed. The statistical model is explained further in the following chapter, but the results
of the simultaneous model will not be reported in this minor thesis. The theoretical framework
for the investigation of the second definition of corporate governance effectiveness in
Indonesia is depicted in figure 3.2 and figure 3.3.
Figure 3.2 suggests one-way relationship between corporate governance and company
performance. Specifically, the corporate governance regulation of Jakarta Stock Exchange is
related to board governance. Therefore, the thesis analyses the relationship between board
governance, which are board of commissioners and audit committee, and company market
performance, proxied by Tobin’s Q. The relationship between company which the board
governance complies with the JSX regulation and company performance is positive. In
addition to board governance as the dependent variable, to examine the relationship between
corporate governance and company performance, some other controlling variables are
considered. They are size of company, type of industry, leverage, ownership (insider
ownership and institutional ownership). The relationship between each of controlling
variables, except industry, and company performance are positive. The sign of the association
between industry and company performance is still unclear, but
Figure 3.3 suggests two-way relationships between corporate governance and
company performance. Literature suggests interrelationship among corporate governance,
ownership structure and company performance. These relationships are endogenous which are
depicted inside the circle as a system. Outside the system are exogenous variables which
influence the system. The exogenous variables are tenure of listing, type of industry, size of
company, leverage, and dual listing in other recognised overseas stock market. The expected
signs is explained in the section 4.5.3.
34
Corporate Governance Characteristics: 1. The Board of Commissioner
a. The board size. b. The proportion of independent
commissioners in the composition of a board
2. The Audit Committee a. The audit committee size. b. The proportion of independent
commissioners in the composition of the audit committee.
c. Board leadership structure. 1). The chairperson is an independent
commissioner. 2). The chairperson is not an independent
commissioner. d. Number of member who hold financial or
accounting qualifications.
Company Performance
Controlling Variables: 1. Size of company (+) 2. Type of industry (+/-) 3. Leverage (+) 4. Ownership structure (Insider ownership (+)
and institutional ownership (+))
Figure 3.2: One-way Relationship between Corporate Governance and Company Performance
(+)
35
Finally, three types of research will be conducted: descriptive, explanatory and
evaluative research. The descriptive study describes the corporate governance practice of the
JSX listed companies. Then, using explanatory research, this thesis seeks answers to two
issues: the factors influencing the corporate governance practice of the JSX listed companies
and the interrelationship between corporate governance and company performance. Finally,
all results from these two former studies allow the researcher to judge whether the corporate
governance practice in Indonesia is effective.
Figure 3.3.: Interrelation between Corporate Governance and Company Performance
Ownership structure (Insider ownership and institutional ownership)
Corporate Governance
Practice; relating to: Characteristics of Board Governance
Company Performance
(Accounting based performance and
Market-based performance)
External/Internal Factors:
1. Tenure of listing
2. Type of industry 3. Size of company 4. Leverage 5. Listing in other
recognised overseas stock market
36
3.2. Research Questions
As outlined above, this thesis focuses on four broad research questions:
RQ 1: To what extent do JSX listed companies comply with the JSX corporate governance
rules?
RQ 2: Are external and internal factors related to the corporate governance practice of the
JSX listed companies?
RQ 3: Are board governance related to company performance?
RQ 4: How is the relationship between corporate governance practices and company
performance?
As mentioned in the previous paragraph, the first question is investigated through a
descriptive study. The corporate governance practices of the JSX listed companies were
assessed using a checklist instrument based on the JSX corporate governance rules. The
explanation of the construction of this checklist instrument is explained in the following
chapter.
In examining the factors influencing the corporate governance practice of companies,
the specific issues investigated were:
1. The effect of company size on the corporate governance practice of the JSX listed
companies;
2. The effect of type of industry on the corporate governance practice of the JSX listed
companies;
3. The effect of ownership structure (percentage of institutional ownership) on the corporate
governance practice of the JSX listed companies;
4. The effect of leverage on the corporate governance practice of the JSX listed companies;
37
5. The effect of the previous companies’ performance on the corporate governance practice
of the JSX listed companies;
6. The effect of listing in overseas capital market on the corporate governance practice of the
JSX listed companies;
7. The effect of the length of time since the company listing on the corporate governance
practice of the JSX listed companies;
Having examined the factors influencing company performance, then, specific issues
investigated to answer the relationship between board governance and company performance
were:
1. The relationship between board of commissioners’ size and company performance.
2. The relationship between composition of independent commissioners and company
performance.
3. The relationship between independency of audit committee and company performance.
4. The relationship between other audit committee’s quality (led by an independent
commissioner and consists of at least one of members having accounting/ financial
qualifiactions), compliance with the JSX corporate governance regulation, and company
performance.
5. The relationship between size of audit committee and company performance.
6. The relationship between size of company and company performance.
7. The relationship between leverage of company and company performance.
8. The relationship between institutional ownership (of unrelated institutions) and company
performance.
9. The relationship between institutional ownership (of related institutions) and company
performance.
38
10. The relationship between insider ownership and company performance.
Finally, to answer how the relationship between corporate governance practices and
company performance, the specific issue investigated is whether there is endogenous
relationship among corporate governance, ownership structure and company performance.
3.3. Hypotheses
Based on the research questions above, the hypotheses which were tested to answer the
second broad research question are as follows.
1. The size of a company is significant in explaining the compliance of JSX listed companies
with the JSX corporate governance guidelines;
2. The type of industry is significant explaining the compliance of JSX listed companies with
the JSX corporate governance guidelines;
3. The ownership structure (percentage of institutional ownership) is significant explaining
the compliance of JSX listed companies with the JSX corporate governance guidelines;
4. The leverage is significant explaining the compliance of JSX listed companies with the
JSX corporate governance guidelines;
5. The previous companies’ performance is significant explaining the compliance of JSX
listed companies with the JSX corporate governance guidelines;
6. The dual listing of companies in overseas capital market is significant explaining the
compliance of JSX listed companies with the JSX corporate governance guidelines;
7. The length of time since the company listing is significant explaining the compliance of
JSX listed companies with the JSX corporate governance guidelines;
Then, hypotheses which were tested to answer the relationship between board governance
characteristics and company performance are as follows.
39
1. The board of commissioners’ size is positively related to company performance.
2. The composition of independent commissioners is positively related to company
performance.
3. The independency of audit committee is positively related to company performance.
4. The audit committee’s leadership structure, a achairman is an independent commissioner,
is positively related to company performance.
5. The financial/accounting qualification of audit committee’s members is positively related
to company performance.
6. The size of audit committee is positively related to company performance.
7. The size of company is positively related to company performance.
8. The leverage of company is related positively to company performance.
9. The institutional ownership (of unrelated institutions) is positively related to company
performance.
10. The institutional ownership (of related institutions) is not related to company
performance.
11. The insider ownership is positively related to company performance.
12. There are interrelations among corporate governance, company performance, and
ownership structure.
3.4. Operationalising Key Concepts and Research Instruments
Several descriptive studies on corporate governance practice in Indonesia were
described in the previous chapter (JSX, 2003; CGFRC-Standard & Poor’s 2004; World Bank,
2004). This thesis broadens the former studies by investigating three-year observations rather
than a single year observation. The method used in this thesis to describe the corporate
governance in Indonesia follows the former studies where an index of corporate governance
40
using a checklist instrument was constructed (Gompers, Ishii, and Metrick, 2003; Brown and
Caylor, 2005b; Black, Jang, and Kim, 2006). The details of the construction are explained in
chapter 4. The checklist was specifically designed to disclose the characteristics of the
companies and their compliance with the JSX corporate governance rules practice of the JSX
listed companies; therefore, it is applied to answer the first and second broad research
questions.
To answer the third question, this paper does not use the results of the checklist.
Instead, this study examines the specific governance practices related to operation of their
boards. This enables the individual effects of board governance structure to be identified. The
definitions of board governance structure are derived from the JSX corporate governance
regulations as explained in the following section describing the research model.
Finally, having described the compliance of companies with corporate governance
regulations, another definition of corporate governance effectiveness measured by company
performance needs to be operationalised. Similar to the former studies, accounting based
performance and market-based performance measures were used as proxies (Darmawati,
Khomsiyah, and Rahayu, 2004; Kiel and Nicholson, 2003). The proxy for accounting based
performance is Return on Assets (ROA) and Return on Equity (ROE) while the proxy for
market-based performance is Tobin’s Q (Q). These variables are discussed more extensively
in chapter 4.
41
CHAPTER IV
RESEARCH METHODOLOGY
4.1. Available Research Methods
In order to deploy the theoretical framework detailed in chapter 3, this study finds that
the research method usually used in the exploration of corporate governance topics is
empirical research. In empirical research, the researchers rely on data drawn from
observations or experience. Indeed, the researchers collect the empirical data supported by
constructing a systematic research design and reliable research instruments. In fact, based on
the literature review as shown in appendix 1, almost all of the previous studies used archival
data as the source of the studies. Furthermore, the checklist instrument is employed, i.e. to
measure the corporate governance index and to collect the archival data. A survey research
method was used to collect the primary data.
This thesis applies empirical research to investigate the effectiveness of corporate
governance practice in Indonesia. Indeed, empirical research is suitable because it is
‘generally concerned with establishing the relationships between variables’ (Ryan, Scapens,
and Theobald 2002, p.118). Given cost and time constraints, this paper believes that the
secondary data from reliable sources is the best option to be used to collect the empirical
evidence.
4.2. Construction of a Corporate Governance Checklist
The format of this study’s checklist follows the previous studies (Gompers, Ishii, and
Metrick, 2003; Brown and Caylor, 2005b; Black, Jang, and Kim, 2006). However, the content
42
of the checklist was based on two main codes of Indonesian corporate governance; the code
issued by the National Committee on Corporate Governance of Indonesia (NCCG) and the
JSX decree on corporate governance practice. The checklist is presented in table 4.1.
Turning to the assessment of corporate governance practice, and similar to other
corporate governance indices, a ‘0 or 1 score’ assessment method was applied; each company
was scored ‘1’ for the implementation of each corporate governance principles. The total
score of a company having full compliance with corporate governance principles is 17.
4.3. Data
As indicated in the previous section, because the corporate governance regulation
issued by the Jakarta Stock Exchange (JSX) was imposed on the JSX listed companies, the
target population of this study is the JSX listed companies. However, this paper excludes bank
and financial companies due to two specific reasons: firstly, there are other specific
regulations imposed on these companies, i.e. regulations issued by Indonesian central bank
specifically concerned with the prudential issues in banks; secondly, these companies’
performances are measured with specific financial indicators, i.e. net performing loan (NPL)
and Capital Adequacy Ratio (CAR).
This study uses secondary data: annual reports and stock prices, which are available in
the JSX website. A company’s Annual Report adequately discloses Corporate Governance
Practice. Therefore, the only criteria that must be fulfilled by the companies to be selected are
that their annual reports and information on stock prices for period 2002-2004 are available in
the JSX website. Inaccessibility of this information over the observation periods excluded a
company from the research population.
43
Table 4.1. : Corporate Governance Assessment Checklist
Principles of Corporate Governance ScoreA. Disclosure about Corporate Governance Practice There is disclosure of adherence to the principles of Good Corporate Governance composed by the National Committee on Corporate Governance. OR There is disclosure for any discrepancies from and/or non-compliance with such principles, including reasons therefore.
1
B. Disclosure about Board of Commissioners 1. The size of the board. 1 2. The composition of the board: the number of independent commissioners is at least 20%. 1 3. Identity of commissioners (other than names) the educational background, and the career background. 1 4. The establishment of such committees other than audit committee (such as nomination
committee, remuneration committee) 1 C. Disclosure about Board of Directors 1. The size of the board. 1 2. Identity of directors (other than names) the educational background, and the career background. 1 D. Disclosure about Audit Committee 1. The size of the committee. 1 2. The composition of the committee: at least one independent commissioner (as the chairman) and minimum two outsiders. 1 3. The educational background and the career background, i.e. finance or accounting, of committee member. 1 4. There is a letter describing the Audit Committee’s duties and responsibilities during the year under review 1 E. Other matters that important to Decision Making 1. The company’s objectives, business goal and strategies. 1 2. The ownership structure, including the shares owned by commissioners and directors (not more than 20%) 1 3. The status of major shareholders and all other shareholders and pertinent information on
the exercise of shareholders’ rights. 1 4. Evaluations of the company by external institutions such as external auditors, credit
rating agencies and others 1 5. The remuneration systems for internal auditors, commissioners, directors, and key executives. 1 6. Material foreseeable risk factors, including management assessment of business climate and risk factors. 1 TOTAL SCORE 17
44
4.4. Research Design
Amongst the research designs of empirical research, e.g. pre-test/post-test design,
interrupted time series designs, correlation designs, and ex post facto designs, the correlation
design is the most familiar to the scholars in accounting and finance (Ryan, Scapens, and
Theobald 2002, p.127). The literature review, which was discussed in chapter 3, also shows
that the correlation design is the type of research design commonly used in investigation of
corporate governance topics, especially in the investigation of relationships between corporate
governance variables and accounting/financial measurements.
Similar to the other research in corporate governance studies, this paper applies the
correlation design to investigate the correlation between corporate governance and company
performance. Furthermore, to answer the research questions, a combination between time-
series and cross-sectional study: a pooled-study/panel data analysis is applied. It is a time-
series study because the data collection period is from 2002-2005. It also can be defined as a
time-series study as the data comes from a number of listed companies in the JSX.
4.5. Empirical Design: Variables and Measurements
The variables investigated are listed in Tables 4.1 and 4.2.
4.5.1. Factors influencing corporate governance practice
4.5.1.1. Dependent variables
In the examination of factors influencing corporate governance practice, the result
(total score) from the corporate governance checklist (Table 4.1) is used as the dependent
variable.
45
4.5.1.2. Independent variables
a. Company size
There is no specific category for small and large companies in the JSX, therefore, similar to
previous studies (Black, Jang and Kim, 2006; Brown and Caylor, 2005b), this study uses total
assets (ln) as the measurement of company size. For the purpose of the robustness test, the
effect of total sales (ln) of the company was also examined.
b. Type of industry
As Adams and Mehran (2000) identified industry is a matter factor that influence the
corporate governance practice, hence, to observe the effect of industry, this study divides the
companies into two industries, which are trading industry, such as wholesaler, and other than
trading industry. Including in other industry is companies in property industry and investment
industry. While the classification is based on category issued by the Jakarta Stock Exchange
(JSX), the division of industries into two industries: trading and not trading is subjective. This
thesis simply investigates whether industry is a matter explaining the dependent variable:
score of corporate governance practice. The dummy variables will be employed to investigate
this effect.
Industry Dummy Variables Trading industry 0 Others 1
Figure IV.1: Dummy Variables of Type of Industry
c. Ownership structure
Ownership structure is found as one of the key mechanism of an effective corporate
governance practice (Keasey, Thompson, and Wright, 1997 in Firth, Fung and Rui 2002). In
addition, Gillan and Starks (2003) identify that institutional investors increases the
information of the markets where they invest. Further, this information increases the quality
of monitoring of corporations and improves the corporate governance structures. In this paper,
46
two types of ownership were investigated: insider and outsider ownership. Furthermore,
following Cornett, Marcus, Saunders and Tehranian (2003) the outsider ownership is divided
into institutional ownership by an institution, which does not have any business relation with
the company, institutional ownership with business relations such as the holding company and
creditors, and external individuals whose ownership was more than 5%.
d. Leverage
It is believed the composition of debt reflected by leverage ensures a better governance
system as the banks required such governance to minimise the risks (Brick, Palia, and Wang,
2005).
e. Previous company’s performance
As indicated by previous literature (Hermalin and Weisbach, 1988; Evans, Evans, and Loh,
2002) corporate governance practice is influenced by the previous company performance
therefore ROAt-1, ROE t-1 and Q t-1 are included in the empirical model.
f. Listing in overseas international capital market
Allen (2000b, p.28) identifies that companies in Asian countries, which implement an
impressive corporate governance practice, are usually the companies which are listed in other
recognised international capital markets. In addition, this study attempts to confirm the results
of previous research, (for example the study of Black, Jang and Kim, 2006). Therefore, this
thesis includes this variable as a factor influencing compliance of companies with corporate
governance regulation. The variable is employed using dummy variables.
Dual listing Dummy Variables Listing in other capital market 0 Listing only in the JSX 1
Figure IV.2: Dummy Variables of Dual Listing of the Company
47
g. Length of company’s listing period
To confirm the previous study (Black, Jang and Kim, 2006), this paper investigates the effect
of the listing period of company in the JSX. Black, Jang and Kim (2006, p.29) found the
effect of this variable is negative as ‘the younger firms are likely to be faster-growing and
perhaps more intangible asset-intensive.’
4.5.2. The relationship between corporate governance practice and company
performance
4.5.2.1. Dependent variables
This paper uses Return on Equity (ROE) and Return on Assets (ROA) as the operating
measurement of the company performance. The difference between these operating
performances measures reflects the financial leverage: liabilities. If there are no liabilities in a
company, then ROE must be equal to ROA. In fact, ROE measures specifically how effective
a company's management uses investors' money: shareholders’ equity. Nonetheless, previous
studies found the different results of the relationship between corporate governance index and
operating performance using ROA and using ROE (Brown and Caylor, 2005a). Therefore, it
is interesting to investigate both operating performance so that the result of this study
replicates their analysis in previous studies. The mathematical equations of ROA and ROE are
as follows.
Net Income ROA = Average Total Assets
Net Income – Preferred Dividend ROE = Average Common Stockholders’ Equity
Having defined the operating performance measurements, this paper uses Tobin’s Q as
the measure of company market-based performance. As contemporary literature suggests that
using Tobin’s Q is an appropriate means of assessing the firm performance. A high Tobin’s
Q, the value is greater than 1, suggests a high market value for the company’s assets. The
48
calculation of Tobin’s Q is as follows (Bhagat and Black, 2002 adapted from Kee H. Chung
& Stephen W. Pruitt, 1994)
Market Value of Asset Tobin’s Q = Book Value of Asset
MVCS+BVPS+BVLTD = BVTA Where:
MVCS : Market Value of Common Stock
BVPS : Book Value of Preferred Stock
BVLTD : Book Value of Long Term Debt
BVTA : Book Value of Total Asset
4.5.2.2. Independent variables
a. Characteristics of board of commissioners
Three characteristics are investigated: size of the board, composition of independent
commissioners, and board leadership. Regarding to the JSX corporate governance regulation,
there is no specific requirement for the size of board of commissioners. Nonetheless, literature
review in chapter 3 identified inconclusive results that remain to be investigated. This paper
posits the relationship between these variables can be positive or negative.
Next, regarding to the composition of independent commissioners, chapter 3 also
found that there is growing interest in the appointment of independent commissioners. Indeed,
this type of commissioners is required by corporate governance best practice around the
world. For Indonesian context, the JSX requires the proportion of independent commissioners
in the board is at least 30%. Regardless this requirement, this paper simply measures the
effect of composition of independent commissioners on company performance. This paper
also investigates the independency issue by examining the effect of the board which is led by
an independent commissioner. To investigate the third characteristic, dummy variables are
employed:
49
Board Leader Dummy Variables An independent Commissioner 0 Others 1
Figure IV.3: Dummy Variables of Board Leader
b. Characteristics of audit committee
Similar to board of commissioners, the effect of the size of the audit committee on
company performance is investigated. In addition, the effect of the number of independent
commissioners in the composition of the audit committee is also examined. The JSX requires
an audit committee to consist of at least three members one of which one of the members is an
independent commissioner (JSX, 2003). Regardless of this requirement, this paper simply
measures the relationship between having an audit committee member who is also an
independent commissioner and company performance.
Furthermore, the JSX also requires an audit committee to be led by an independent
commissioner and consist of members who have accounting/financial literacy. Similarly, the
literature review suggests financial/accounting literacy is one of attributes that increase the
effectiveness of an audit committee (BRC, 1999; DeZoort et.a,l 2002; DeFond, Hann, and Hu,
2005; Davidson III, Xie and Xu, 2004). The dummy variables are employed to investigate the
relationship between these audit committee’s characteristics and company performance.
Other Audit Committee Qualities Dummy Variables Led by an independent commissioner and consists of at least one of members having accounting/ financial charactersitics
0
Others 1 Figure IV.4: Dummy Variables of Other Audit Committee Qualities
c. Other controlling variables
Size of company was measured by the value of assets (LnAssets) and sales (LnSales).
It is assumed that the bigger company size is the bigger of capital resources (Demstez and
Lehn, 1985). Hence, the greater resources means the greater opportunity for the company to
50
boost company performance. Similarly, larger sales figures indicate a growth opportunity for
the company to achieve higher company performance. In addition to company size, a leverage
effect is believed to increase company performance (Bodie, Kane, and Marcus, 2005). The
debt composition reflected by leverage also increases the monitoring activities by outsiders.
Similarly, ownership of institution which does not have business relationship with the
company increases the monitoring activities (Cornett, Marcus, Saunders and Tehranian,
2003). Together with outsider factors, the insider factor, insider ownership (shared owned by
management, directors, commissioners), also results in better corporate monitoring activities
(Gillan and Starks, 2003) and is also believed to decrease the agency problem (Jensen and
Meckling, 1976).
4.5.3. The interrelationship among corporate governance practice, ownership and
company performance
4.5.3.1. Endogenous variables
Following Bhagat and Jefferies Jr. (2002), in this simultaneous equation, the
endogenous variables are corporate governance, ownership and performance. In this study,
corporate governance is measured by the corporate governance index resulted from the
corporate governance checklist. Then, ownership is measured by institutional ownership. This
paper follows previous studies (Gillan and Starks, 2003; Cornett, Marcus, Saunders and
Tehranian, 2003) which posits that the ownership of institution, having no business
relationship with the company, increases the monitoring activities. Finally, performance is
measured by Tobin’s Q, ROE and ROA (Bhagat and Black, 2002; Brown and Caylor, 2005a).
4.5.3.2. Exogenous variables
For the simultaneous equation, controlling variables that are determined from outside
the system are tenure of listing of a company in JSX study, type of industry, leverage, size of
51
company and dual listing of a company in overseas stock market. These exogenous variables,
explained further below, influence one of the models of the simultaneous system.
Firstly, variables determined company’s performance are similar with independent
variables of OLS model discussed in the previous chapter. Besides corporate governance and
ownership as the endogenous variables, the exogenous variables influencing company
performance are company size and leverage. Their expected signs have been discussed
previously in section 4.5.2.
Next, the variables influencing corporate governance are also similar with independent
variables discussed previously in section 4.5.2. Variables other than endogenous variables:
ownership structures and company’s performance, which influence corporate governance are
length of listing of a company in the stock exchange (Black, Jang and Kim, 2006), industry
(Adams and Mehran, 2000), company size (Black, Jang and Kim, 2006; Brown and Caylor,
2005b), leverage (Brick, Palia, and Wang, 2005), and dual listing of a company in overseas
(Allen, 2000b). Their expected signs have been discussed previously in section 4.5.2.
Finally, ownership structure, following the study of Demsetz and Lehn (1985), is
influenced by firm size and industry. As explained and found by Demsetz and Lehn (1985):
firm size (proxied by equity) is negatively related to ownership concentration and industry is
significant explaining ownership concentration. Demsetz and Lehn (1985) argued that the
larger size of company size is the smaller share of the firm. This is because to maintain
ownership concentration, the larger company faces an increasing cost of capital. Therefore, to
minimise the costs, the option is diffusion of its ownership.
4.6. Statistical Model and Data Analysis
As indicated in the research model in chapter 3, three types of research are employed
by this paper. They are descriptive, explanatory and evaluative research. Therefore, for the
52
descriptive research, descriptive analysis is conducted. Then, to explain and evaluate
corporate governance practice in Indonesia, the relationship analysis is explored. The analysis
uses the statistic software Eviews version 4.
The parametric statistic, namely logistic regression analysis, is applied to analyse
factors influencing corporate governance practice in the JSX companies.
The model is as follows:
Z (x) = ln ⎟⎟⎠
⎞⎜⎜⎝
⎛
− i
i
p
p
1 = β0 + β1 Big + β2 Ind + β3 Lev + β4 ROAt-1 + β5 Dual
+ β6 InsNot + β7 LnAge + ε
(1)
Where:
ln ⎟⎟⎠
⎞⎜⎜⎝
⎛
− i
i
p
p
1 = Log odd ratio for company’s compliance with the JSX corporate governance
regulation.
pi : Probability for occurance that company’s compliance with the JSX corporate
governance regulation.
1- pi : Probability for occurance that a company does not comply with the JSX corporate
governance regulation.
Big : Log of size of company (LnAssets or LnSales).
Ind : Dummy variables for type of industry.
Lev : Leverage.
ROAt-1 : Previous company performance (also check for ROE t-1 and Q t-1)
Dual : Dummy variables for listing in overseas.
InsNot : Institutional ownership (unrelated institution).
LnAGE : Log of length of listing period of a company in the JSX.
For logistic regression:
Z (x) = ln ( )( )⎥
⎥⎦
⎤
⎢⎢⎣
⎡
=
=
xY
xY
0Pr
1Pr= ln ⎟⎟
⎠
⎞⎜⎜⎝
⎛
− i
i
p
p
1 = β0 + β1 x1+ β2 x2 + βp xp (2)
53
Therefore, the probability for the model is:
pi = Pr ( )xY 1= = ⎟⎟⎠
⎞⎜⎜⎝
⎛
+ z
z
e
e
1 (3)
1- pi = Pr ( )xY 0= = ⎟⎟⎠
⎞⎜⎜⎝
⎛
+ ze1
1 (4)
Next, to investigate the relationship between corporate governance and company
performance, multiple regressions followed by a test of endogenous problem (Durbin wu-
husman test) are conducted. The statistical model for multiple regression is as follows.
Tobin’s Q = α0 + α 1 BSize + α 2 BLdr + α 3 BIdp + α 4 ACIdp + α 5 ACothers
+ α 6 ACSize + α 7 Big + α 8 Lev + α 9 Mgt + α 10 InsNot + α 11 InsRltd +
α 12 Block + ei
(5)
Where:
Tobin’s Q: Company performance (checking for ROA and ROE also).
BSize : Board of commissioners’ size (Ln).
BLdr : The board of commissioners is led by an independent commissioner.
BIdp : Composition of Independent commissioners in board of commissioners.
ACIdp : Composition of Independent commissioners in audit committee.
ACothers : Other qualities of audit committee comply with Indonesian corporate goveranance
regulation: The audit committee is led by Independent commissioner and consists
of members having financial/accounting literacy.
ACSize : Size of audit committtee (Ln).
Big : Size of company (LnAsset or LnSales).
Lev : Leverage.
Mgt : Insider ownership.
InsNot : Institutional ownership, unrelated parties.
InsRltd : Institutional ownership, related parties.
Block : Outsider ownership (individual) with ownership more than 5%.
54
Following the multiple regression is identification for the endogenous problem. If the
endogenous problem is identified, a simultaneous equation will be employed. The models are
as follows.
Tobin’s Q = µ0 + µ1 CG + µ2 InsNot + µ3 Big + µ4 Lev + ei (6)
CG = µ0 + µ1 InsNot+ µ2 Tobin’s Q+ µ3 Age + µ4 Ind + µ5 Big+ µ6 Lev + µ7 Dual + ei (7)
InsNot = µ0 + µ1 Tobin’s Q + µ2 CG + µ3 Big + µ4 Ind + ei (8)
Where:
Tobin’s Q : Company performance (checking for ROA and ROE also).
CG : Corporate Governance Index
InsNot : Ownership of Institution which does not have business relationship with the
company.
Age : Tenure of listing in JSX
Ind : Type of industry.
Lev : Leverage.
Big : Size of company (LnAsset or LnSales).
Dual : Dual listing of a company in overseas stock market .
55
Table 4.2. : Operationalising Key Concepts
Description of Key Concepts Notations
Implementation of Corporate Governance Principles
Corporate Governance Index
COMPLY
CG
Firm Performance
1. Accounting performance: Return on Equity and Return and Assets 2. Market-based performance
ROE, ROA Tobin’s Q
Corporate Governance Practice 1. The Board of Commissioner Characteristics
a. The board size. b. The composition of independent commissioners.
BSize BIndp
2. The Audit Committee Characteristics. a. The board size. b. The composition of independent commissioners in the board. c. Audit committee’s leadership structure. d. The career/educational background of the board members; the
composition of board members having financial or accounting background.
ACSize ACIdp ACLdr ACFin
Ownership a. Insider ownership b. Institutional ownership-unrelated parties c. Institutional ownership-related parties
Mgt InsNOT
InsRLTD
Other Variables 1. Size of company 2. Type of industry 3. Leverage 4. Previous company performance
a. Accounting performance: ROA (ROE) b. Market performance: Tobin’s Q
5. Listing of company in other international stock exchange 6. Institutional ownership -unrelated 7. Tenure of listing in the JSX
Big Ind Lev
ROA t-1 (ROE t-1)
Tobin’s Q t-1 Dual
InsNot Age
56
CHAPTER V
RESULTS OF THE STUDY: THE RELATIONSHIP BETWEEN CORPORATE
GOVERNANCE AND COMPANY PERFORMANCE
5.1. Introduction
This chapter reports the results of the corporate governance study in Indonesia. As
noted in the previous chapter, the further study is planned to address the results of possible
statistical models not addressed here. Nonetheless, for the completion of this minor thesis, the
study reports the results of applying linear regression with the proxy variable, Tobin’s Q, as
the measure of performance.
From 315 companies (including bank and financial companies), the total of the JSX
companies which met the criteria for inclusion in the study were 46 companies. Therefore,
within three years, this study examined 138 observations.
5.2. Descriptive Statistics
Descriptive statistics of the sample are reported in table 5.1 and table 5.2. The mean of
Tobin’s Q increases from 0.465 to 0.831 within three years. In addition, the minimum of
Tobin’s Q value increases to 0.143 from just 0.031 in 2002. Indeed, this increasing trend of
Tobin’s Q suggests better economic conditions in Indonesia and, specifically, a more
favourable condition for the Jakarta Stock Exchange as the stock market. This is also
supported by a decreasing trend in the leverage of Indonesian companies. As shown in the
table, the mean of leverage decreases from 0.981 in 2002 to 0.273 at the end of 2004 while the
maximum leverage also decreases dramatically to 0.268 from 27.208 in 2002.
57
Turning to the concentration of ownership, the concentration of institution ownership,
individual outsider ownership and insider ownership is varied. In fact, table 5.1 shows over
three periods, the ownership of Indonesian companies is concentrated in institutions which
have no business relationship (INSNOT) with the company. The percentage of ownership of
this type of institution remains at the level of 30% on average while the ownership of
institutions which have business relationship (INSRLTD) with the company remains at 0.3%
over the last two periods. Similarly, the ownership of manager or commissioners (MGT) in
the company stays at level 0.2% over three periods. Finally, the figure of individual outsider
ownership (BLOCK) with maximum ownership: 93.1% suggests there is still a company in
the JSX controlled by a dominant individual.
Table 5.1 also describes governance issue in the JSX listed companies. Indeed, the
table shows how varied is the board of commissioners of the companies. Firstly, over three
period of observations, while there is a company which has four members of board of
commissioners, there is also a company which appoints 13 commissioners to their board.
Nonetheless, the average members of board, from 2002-2003, remains constant at four
members (ln BSize). The second argument showing how varied is the governance of the JSX
listed companies is the composition of independent commissioners. There is a company which
still does not have any independent commissioner in its board while there is another company
in which its board consists of 60% of independent commissioners. Nonetheless, the
composition of independent commissioners on average is not more than 40% but not less than
30%; just meeting the minimum requirement of the composition of independent
commissioners, which is 30%.
Finally, table 5.1 describes the audit committees of the JSX companies. The audit
committee size (ln ACSize), on average, is three members. In contrast, with the figure of
board of commissioners, there is no significant gap in audit committee size as the
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minimum/ maximum number of the committee is three members. Including in the audit
committee is one independent commissioner; reflected by the mean of variable ACIDP (an
independent commissioner who also an audit committee member) which is 33%.
Table 5.1: Descriptive Statistics
obs 2002 2003 2004 obs 2002 2003 2004 Mean Q? 0.465 0.651 0.831 Mean MGT? 0.022 0.024 0.023Med Q? 0.336 0.579 0.642 Med MGT? 0 0 0Sd Q? 0.528 0.534 0.721 Sd MGT? 0.06 0.064 0.064Min Q? 0.031 0.115 0.143 Min MGT? 0 0 0Max Q? 3.467 3.369 3.892 Max MGT? 0.288 0.288 0.288Mean AGE? 7.777 8.777 9.777 Mean BSIZE? 1.458 1.443 1.48Med AGE? 8 9 10 Med BSIZE? 1.386 1.498 1.386Sd AGE? 4.2 4.2 4.2 Sd BSIZE? 0.427 0.454 0.475Min AGE? 0.417 1.417 2.417 Min BSIZE? 0.693 0.693 0.693Max AGE? 18.833 19.833 20.833 Max BSIZE? 2.398 2.639 2.639Mean LEV? 0.981 1.225 0.273 Mean BIDP? 0.337 0.367 0.367Med LEV? 0.253 0.313 0.268 Med BIDP? 0.333 0.333 0.333Sd LEV? 3.981 5.437 1.601 Sd BIDP? 0.12 0.118 0.127Min LEV? -0.004 -0.716 -9.451 Min BIDP? 0 0 0Max LEV? 27.208 37.112 3.163 Max BIDP? 0.6 0.6 0.667Mean INSNOT? 0.34 0.307 0.305 Mean ACSIZE? 1.116 1.146 1.14Med INSNOT? 0.25 0.2 0.239 Med ACSIZE? 1.099 1.099 1.099Sd INSNOT? 0.306 0.294 0.287 Sd ACSIZE? 0.086 0.129 0.124Min INSNOT? 0 0 0 Min ACSIZE? 1.099 1.099 1.099Max INSNOT? 0.975 0.923 0.874 Max ACSIZE? 1.609 1.609 1.609Mean BLOCK? 0.005 0.294 0.285 Mean ACIDP? 0.332 0.316 0.322Med BLOCK? 0 0.238 0.208 Med ACIDP? 0.333 0.333 0.333Sd BLOCK? 0.02 0.302 0.3 Sd ACIDP? 0.108 0.079 0.088Min BLOCK? 0 0 0 Min ACIDP? 0 0 0Max BLOCK? 0.105 0.931 0.931 Max ACIDP? 0.75 0.5 0.6Mean INSRLTD? 0.302 0.003 0.003 Mean BIG? 27.469 27.448 27.492Med INSRLTD? 0.25 0 0 Med BIG? 27.642 27.742 27.938Sd INSRLTD? 0.305 0.017 0.017 Sd BIG? 1.45 1.492 1.789Min INSRLTD? 0 0 0 Min BIG? 24.43 24.282 22.623Max INSRLTD? 0.931 0.105 0.105 Max BIG? 30.896 30.942 31.298Definition: Q : Tobin’s Q AGE : Listing period of a company in the JSX LEV : Leverage INSNOT : Ownership (%) of institution which has no relationship with the company BLOCK : Ownership (%) of individual outside of the company INSRLTD : Ownership (%) of institution which has relationship with the company (such as
parent or subsidiary company) MGT : Ownership (%) of individual inside of the company ACSIZE : Size of audit committee ACIDP : Number of independent commissioners in audit committee BIG : Size of company in terms of assets
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Overall, the figure related to board governance of Indonesian companies shows most
of the companies comply with the corporate governance regulation. However, this condition
indicates the minimal condition for corporate governance implemented by the companies. The
composition of independent commissioners, 30%, and the structure of audit committee, three
members, just hit the minimum requirement of the regulation. In fact, there are still companies
which does not have any independent commissioners despite the requirement of corporate
governance regulation in place since 2002. Indeed, the codes of corporate governance around
the world believe an independent commissioner is a desirable matter. In addition, the theory
of Berle and Means (1932) suggests this type of commissioner (director) increases the
effectiveness of monitoring and the strategic planning role of the board (Farrar, 2005).
5.3. Regression Analysis and Tests for OLS Assumptions
As noted before, this part reports the investigation of the relationship between
corporate governance and company performance. Therefore, the method namely Ordinary
Least Square (OLS) is applied. To make OLS produces a BLUE (Best, Linear, Unbiased,
Efficient) estimator there are classical assumptions to be met. These are discussed later in the
next part.
5.3.1. Regression analysis of preliminary estimated model
The first regression model of the study is shown in table 5.3. The R-square suggests
that only 12.62% of variance in company performance can be explained by the model. In fact,
the F-statistic (p-value > 5%) suggests the overall model is insignificant. Indeed, with
significant level 5%, only the size of audit committee significant influences company
performance. While, with significant level 10% ownership of management is also significant.
The size of audit committee relates positively with company performance while management
ownership relates negatively with company performance.
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Table 5.2: Descriptive Statistics
Q? AGE? LEV? INSNOT? BLOCK? INSRLTD? MGT? BSIZE? BIDP? ACSIZE? ACIDP? BIG? Mean 0.649 8.777 0.826 0.317 0.195 0.103 0.023 1.46 0.357 1.134 0.323 27.47 Median 0.5 8.792 0.269 0.232 0 0 1.05E-05 1.386 0.333 1.098612 0.333 27.776 Maximum 3.892 20.833 37.112 0.975 0.931 0.931 0.288 2.639 0.667 1.609 0.75 31.298 Minimum 0.031 0.417 -9.451 0 0 0 0 0.693147 0 1.098612 0 22.623 Std. Dev. 0.615 4.249 3.99 0.294 0.279 0.225 0.062 0.45 0.121 0.114 0.092 1.573 Skewness 3.139 0.121 7.5 0.445 1.032 2.038 3.354 0.224 -0.531 3.228 -0.557 -0.287 Kurtosis 15.271 2.682 64.664 1.863 2.523 5.783 13.242 2.596 4.428 12.348 12.515 3.368 Jarque-Bera 1092.503 0.917 23158.07 11.992 25.806 140.048 861.812 2.088 18.213 742.169 527.676 2.671 Probability 0 0.632 0 0.00249 0.000002 0 0 0.352113 0.000111 0 0 0.263 Sum 89.57 1211.25 114.032 43.775 26.848 14.215 3.144 201.548 49.281 156.464 44.6 3790.834 Sum Sq. Dev. 51.874 2473.585 2181.153 11.82 10.636 6.96 0.528 27.687 2.022 1.796 1.156 338.918 Observations 138 138 138 138 138 138 138 138 138 138 138 138 Cross sections 46 46 46 46 46 46 46 46 46 46 46 46
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Table 5.3: First Output of Model
Dependent Variable: TOBINSQ Method: Least Squares Date: 07/22/06 Time: 00:09 Sample: 1 138 Included observations: 138
Variable Coefficient Std. Error t-Statistic Prob. C -0.886766 1.23021 -0.720825 0.4724
BSIZE 0.086238 0.143562 0.600704 0.5491 BLDR 0.11655 0.156999 0.742366 0.4593 BIDP 0.588906 0.471364 1.249366 0.2139
ACSIZE 1.468421 0.53351 2.752379 0.0068 ACIDP 0.185565 0.730686 0.25396 0.7999
ACOTHERS 0.074435 0.312367 0.238293 0.812 BIG -0.026414 0.044343 -0.595667 0.5525
LEVERAGE 0.002926 0.013204 0.221593 0.825 MGT -1.690185 0.990417 -1.706539 0.0904
INSNOT 0.287307 0.28954 0.992289 0.323 INSRLTD -0.153475 0.335812 -0.457027 0.6484 BLOCK 0.287393 0.30423 0.944658 0.3467
R-squared 0.126166 Mean dependent var 0.649055 Adjusted R-squared 0.042277 S.D. dependent var 0.615338 S.E. of regression 0.60219 Akaike info criterion 1.912977 Sum squared resid 45.32906 Schwarz criterion 2.188733 Log likelihood -118.9954 F-statistic 1.503974 Durbin-Watson stat 1.646448 Prob(F-statistic) 0.131104
5.3.2. OLS Classical Assumptions for Preliminary Estimated Model
• Misspecification errors: Ramsey’s RESET test
Misspecification test:
H0 : γ1 = 0
H1 : γ 1 ≠ 0 (misspecification error)
H0 is rejected if F the statistic value is bigger than the F critical value. Rejecting H0
implies the original model is inadequate and can be improved. A failure to reject H0 says the
test has not been able to detect any misspecification. Ramsey’s RESET test on table 5.4
indicates no misspecification error in this preliminary model.
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Table 5.4: Test for Misspecification Errors
Ramsey RESET Test: F-statistic 2.834167 Probability 0.041068 Log likelihood ratio 9.297247 Probability 0.025589 Test Equation: Dependent Variable: TOBINSQ Method: Least Squares Date: 07/22/06 Time: 01:21 Sample: 1 138 Included observations: 138
Variable Coefficient Std. Error t-Statistic Prob. C 2.26491 4.768087 0.475014 0.6356 BSIZE -0.073188 0.42712 -0.171353 0.8642 BLDR -0.099697 0.57075 -0.174677 0.8616 BIDP -0.077425 2.734591 -0.028313 0.9775 ACSIZE -1.841228 6.610274 -0.27854 0.7811 ACIDP -0.494039 1.182287 -0.417867 0.6768 ACOTHERS -0.129027 0.467717 -0.275866 0.7831 BIG 0.009334 0.127303 0.073324 0.9417 LEVERAGE -0.001717 0.018588 -0.092385 0.9265 MGT 1.319526 7.553084 0.1747 0.8616 INSNOT -0.253922 1.391178 -0.182523 0.8555 INSRLTD -0.081883 0.801181 -0.102204 0.9188 BLOCK -0.218314 1.374389 -0.158844 0.8741 FITTED^2 3.732627 11.65201 0.320342 0.7493 FITTED^3 -4.952465 11.77442 -0.420612 0.6748 FITTED^4 2.47599 3.999239 0.619115 0.537 R-squared 0.183098 Mean dependent var 0.649055 Adjusted R-squared 0.082659 S.D. dependent var 0.615338 S.E. of regression 0.589358 Akaike info criterion 1.889084 Sum squared resid 42.37578 Schwarz criterion 2.228476 Log likelihood -114.3468 F-statistic 1.822976 Durbin-Watson stat 1.689298 Prob(F-statistic) 0.038545
Ramsey test F-statistic = 2.834167; F critical value= 2.68 (df restricted=3; df unrestricted 138-15-1=126) so that Fcritical < Fstat. P-value is 0.041068 < 0.05 (significant level). Both F-value and p-value suggest accept Ho; the test has not been able detect misspecification error.
• Tests for OLS assumptions: Multi-collinearity
The rule of thumb |rij| ≥ 0.8 says high pair-wise correlation among independent
variable i and j, hence high multi-collinearity is likely to happen. Based on the correlation
matrix in table 5.5, there is no detection of a multi-collinearity problem.
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Table 5.5: Test for Multi-collinearity
TOBINSQ BSIZE BLDR BIDP ACSIZE ACIDP ACOTHERS BIG LEVERAGE MGT INSNOT INSRLTD BLOCK TOBINSQ 1 0.0943 0.0609 0.1490 0.1673 0.0740 -0.0265 0.0651 0.0383 -0.1261 0.1159 -0.1818 0.0613
BSIZE 0.0943 1 0.1275 0.1448 0.1485 0.1829 -0.0720 0.5491 0.0820 0.0446 0.0866 -0.0736 -0.0789 BLDR 0.0609 0.1275 1 0.0139 -0.1275 0.0393 0.0895 0.0367 0.0648 -0.0921 0.0434 -0.0233 -0.0237 BIDP 0.1490 0.1448 0.0139 1 -0.0880 0.2473 -0.2727 0.1756 0.1510 -0.2104 0.1201 -0.0958 -0.0119
ACSIZE 0.1673 0.1485 -0.1275 -0.0880 1 0.0771 -0.0713 0.2958 -0.0391 0.3528 -0.0898 -0.1067 -0.0761 ACIDP 0.0740 0.1829 0.0393 0.2473 0.0771 1 -0.5756 0.1678 0.0186 -0.1126 0.0258 0.1452 -0.0448
ACOTHERS -0.0265 -0.0720 0.0895 -0.2727 -0.0713 -0.5756 1 -0.1116 -0.0350 -0.0839 0.0102 -0.0716 -0.1063 BIG 0.0651 0.5491 0.0367 0.1756 0.2958 0.1678 -0.1116 1 0.1227 -0.0721 -0.0546 -0.0353 -0.1259
LEVERAGE 0.0383 0.0820 0.0648 0.1510 -0.0391 0.0186 -0.0350 0.1227 1 -0.0283 0.0868 -0.0417 -0.0556 MGT -0.1261 0.0446 -0.0921 -0.2104 0.3528 -0.1126 -0.0839 -0.0721 -0.0283 1 -0.1304 -0.0201 -0.0516
INSNOT 0.1159 0.0866 0.0434 0.1201 -0.0898 0.0258 0.0102 -0.0546 0.0868 -0.1304 1 -0.3348 -0.5090 INSRLTD -0.1818 -0.0736 -0.0233 -0.0958 -0.1067 0.1452 -0.0716 -0.0353 -0.0417 -0.0201 -0.3348 1 -0.3106
BLOCK 0.0613 -0.0789 -0.0237 -0.0119 -0.0761 -0.0448 -0.1063 -0.1259 -0.0556 -0.0516 -0.5090 -0.3106 1
With rule of thumb: there is multi-collinearity if |rij| > 0.8, the matrix shows no high correlation amongst independent variables.
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• Tests for OLS assumptions: Heteroskedasticity; White test
Based on White’s test, to test the overall model fit (joint hypothesis of all the
coefficients) a chi-square test was conducted. H0, the overall model is fit, is rejected if the
value of statistic test (n*R2) > Chi-square critical value. The white test in table 5.6 indicates
the preliminary model contains a heteroskedasticity problem.
Table 5.6: White Heteroskedasticity Test:
F-statistic 2.734509 Probability 0.000277 Obs*R-squared 47.39671 Probability 0.001302 Test Equation: Dependent Variable: RESID^2 Method: Least Squares Date: 07/22/06 Time: 02:04 Sample: 1 138 Included observations: 138
Variable Coefficient Std. Error t-Statistic Prob. C 152.8713 27.6493 5.52894 0
BSIZE 0.138979 1.473376 0.094327 0.925 BSIZE^2 -0.111037 0.483244 -0.229774 0.8187
BLDR 0.188519 0.30186 0.624524 0.5335 BIDP 1.301007 3.124063 0.416447 0.6779
BIDP^2 -1.632649 4.319186 -0.377999 0.7061 ACSIZE -8.442764 23.66869 -0.356706 0.722
ACSIZE^2 2.827971 9.09224 0.311031 0.7563 ACIDP 1.641022 3.611602 0.454375 0.6504
ACIDP^2 -2.654438 4.756377 -0.55808 0.5779 ACOTHERS 0.073726 0.700384 0.105265 0.9163
BIG -10.78702 1.882578 -5.729921 0 BIG^2 0.196864 0.034909 5.639278 0
LEVERAGE 0.122594 0.075759 1.61822 0.1084 LEVERAGE^2 -0.003904 0.002303 -1.695415 0.0927
MGT -5.552319 7.915992 -0.701405 0.4845 MGT^2 23.0904 31.72041 0.727935 0.4681 INSNOT 0.209174 1.350924 0.154838 0.8772
INSNOT^2 0.049011 1.540272 0.03182 0.9747 INSRLTD 0.687646 1.9174 0.358635 0.7205
INSRLTD^2 -0.951519 2.606011 -0.365125 0.7157 BLOCK -0.603345 1.532141 -0.393792 0.6945
BLOCK^2 0.72584 2.037501 0.35624 0.7223 R-squared 0.343454 Mean dependent var 0.328471 Adjusted R-squared 0.217854 S.D. dependent var 1.269172 S.E. of regression 1.122443 Akaike info criterion 3.219904 Sum squared resid 144.8859 Schwarz criterion 3.707779 Log likelihood -199.1733 F-statistic 2.734509 Durbin-Watson stat 2.014414 Prob(F-statistic) 0.000277 Obs*R-squared 47.39671 < Chi-square (5%; 22)= 33.924, suggests Heteroskedasticity problem.
65
Because the White test indicates an heteroskedasticity problem in the model, hence
remedy action was executed. The Generalised Least Square Method is the remedy for the
problem. The model is weighted by leverage as the behaviour of leverage influences a
company’s performance behaviour. An increase of leverage increases company performance
but, at a certain level, adding leverage would deteriorate performance, causing bankrupt
problems (Bodie, Kane, and Marcus, 2005). The re-estimated model, based on GLS method,
is shown in table 5.7.
• Tests for OLS assumptions: Serial correlation, Breusch-Godfrey Serial Correlation LM
Test
Table 5.8, Breusch-Godfrey Serial Correlation LM Test indicates no autocorrealation
in the model. P-value RESID(-2) = 0.587 > 5% (significant level); the test fails to detect
autocorrelation. Similarly, Durbin-Watson statistic close to 2, suggests no autocorrelation.
5.3.3. Regression analysis of final model
Tobin’s Q = 1.426 - 0.068 BSize - 0.163 BLdr + 0.958 BIdp + 0.640 ACSize
+ 1.260 ACIdp + 0.330 ACothers - 0.090 Big + 0.303 Lev
+ 0.041 Mgt + 0.311 InsNot + 0.236 InsRltd + 0.334 Block
The final model, based on GLS method, can be formulated as above. The R-square of
the model indicates that 97.65% of variance in company performance can be explained by the
model. Furthermore, with the acceptance of a significant level of 5%, the F-statistic suggests
the overall model is significant (P-value < 5%). Turning to the significance of each
independent variable, the t-statistic suggests that most of independent variables are significant
in explaining Tobin’s Q except three variables. The insignificant variables are size of board of
commissioners, audit committee size and management ownership. The other board
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governance variables: board leadership, board independence, audit committee independence,
other attributes of audit committee have significant association with company performance.
Table 5.7: Remedy for Heteroskedasticity Problem
(Generalised Least Square Method)
Dependent Variable: TOBINSQ Method: Least Squares Date: 07/22/06 Time: 02:58 Sample: 1 138 Included observations: 126 Excluded observations: 12 Weighting series: LEV^(-.5)
Variable Coefficient Std. Error t-Statistic Prob. C 1.426404 0.951686 1.498818 0.1367
BSIZE -0.068077 0.115046 -0.591742 0.5552 BIDP 0.958418 0.263106 3.642708 0.0004 BLDR -0.163166 0.04369 -3.73462 0.0003 ACIDP 1.260287 0.320988 3.926277 0.0001
ACOTHERS 0.330242 0.122759 2.690173 0.0082 ACSIZE 0.639819 0.410395 1.559033 0.1218
BIG -0.090437 0.041623 -2.172758 0.0319 LEV 0.303423 0.126294 2.40252 0.0179 MGT 0.040959 0.800379 0.051175 0.9593
INSNOT 0.31079 0.119768 2.594938 0.0107 INSRLTD 0.236209 0.105006 2.249494 0.0264 BLOCK 0.333681 0.117333 2.843877 0.0053
Weighted Statistics
R-squared 0.976459 Mean dependent var 0.356156 Adjusted R-squared 0.973959 S.D. dependent var 0.990096 S.E. of regression 0.159774 Akaike info criterion -0.73266 Sum squared resid 2.884627 Schwarz criterion -0.440028 Log likelihood 59.15758 F-statistic 125.0036 Durbin-Watson stat 1.633067 Prob(F-statistic) 0
Unweighted Statistics
R-squared -3.655747 Mean dependent var 0.661812 Adjusted R-squared -4.150163 S.D. dependent var 0.630943 S.E. of regression 1.43186 Sum squared resid 231.6753 Durbin-Watson stat 0.604882
The proportionality factor from leverage is chosen because as the ‘behaviour’ of company performance changes as the leverage changes.
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Table 5.8: Serial/Auto-Correlation Test
Breusch-Godfrey Serial Correlation LM Test:
Obs*R-squared 102.1398 Probability 0
Test Equation: Dependent Variable: RESID Method: Least Squares Date: 07/22/06 Time: 03:03 Presample and interior missing value lagged residuals set to zero.
Variable Coefficient Std. Error t-Statistic Prob.
C -1.590422 1.481531 -1.073499 0.2854 BSIZE 0.064684 0.158142 0.409025 0.6833 BLDR 0.23302 0.181131 1.286477 0.201 BIDP -0.099545 0.520244 -0.191343 0.8486
ACSIZE 0.680257 0.596664 1.1401 0.2567 ACIDP -1.04428 0.771362 -1.353814 0.1785
ACOTHERS -0.265765 0.329316 -0.807021 0.4214 BIG 0.0455 0.055273 0.823184 0.4122 LEV -0.277879 0.019399 -14.32418 0 MGT -1.634029 1.05913 -1.542803 0.1257
INSNOT -0.014367 0.315946 -0.045472 0.9638 INSRLTD -0.344494 0.377765 -0.911926 0.3638 BLOCK -0.072081 0.328698 -0.219293 0.8268
RESID(-1) 0.160461 0.084498 1.899004 0.0602 RESID(-2) 0.028415 0.052157 0.544791 0.587
R-squared 0.810633 Mean dependent var 1.26E-15 Adjusted R-squared 0.786749 S.D. dependent var 1.361397 S.E. of regression 0.628681 Akaike info criterion 2.020959 Sum squared resid 43.87166 Schwarz criterion 2.358612 Log likelihood -112.3204 F-statistic 33.94024 Durbin-Watson stat 1.901534 Prob(F-statistic) 0
P-value RESID(-2) = 0.587 > 5% (significant level), therefore the test fails to detect Autocorrelation. Similarly, Durbin-Watson stat closes to 2, suggests no autocorrelation.
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5.4. Hypothesis Testing
This paper found evidence for most of the hypotheses of the relationship between
board governance characteristics and company performance posited in chapter three. In
general, this study found support for compliance with the attributes of board governance,
except board of commissioners’ size and audit committee’s size, and their relationship to
performance represented by Tobin’s Q. This paper also found a significant relationship
between each of controlling variables namely ownership (except insider ownership), leverage,
and company size, and company performance. Therefore, for the investigation of the
relationship between board governance and company performance, this study found the
relationship posited in all hypothesis except hypothesis 1 and 6. The specific results of the
hypothesis testing is explained below.
To begin with, regarding to the board of commissioners attributes, this paper could not
find evidence to support theory suggesting board size is one of factors which contributes to an
effective board. Table 5.7 showed that variable of board commissioners’ size (BSIZE) is not
significant (p > 5%). However, this study found a significant relationship between the other
two attributes of board of commissioners and company performance. The results are
explained in the following paragraphs.
Variable of independence of board of commissioners (BIDP) is positively significant
to company performance (Tobin’s Q). It indicates that the total number of independent
commissioners relates positively to company performance. A 1 % increase in independent
commissioners increases Tobin’s Q by 0.958.
On the other hand, leadership of board of commissioners is negatively significant to
Tobin’s Q. It indicates that the performance of companies in which the board of
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commissioners is not led by an independent member is different from a company that has an
independent commissioner as a chairperson of the board.
Turning to the characteristics of audit committee, this study found significant
relationships of variable audit committee independence (ACIDP) and other audit committee
quality (ACOTHERS), and company performance. The composition of audit committee
members who are also independent commissioners relates positively to company
performance. A 1 % increase of independent commissioners who are also audit committee
members increases Tobin’s Q by 1.26.
Regarding to the other characteristics of a good audit committee, the expectation of a
positive relationship between audit committee characteristics and company performance
cannot be found. This thesis finds that the performance of a company which complies with the
regulation; led by an independent commissioner and having a minimum of three members of
an audit committee including at least one member with an accounting/financial background, is
significantly different from the company without these attributes in its audit committee. The
performance of companies without these audit committee attributes is greater by 0.33
compared with a company which complies with the regulation.
Finally, similar to the variable of size of board of commissioners, the variable of audit
committee size is also shown insignificant to Tobin’s Q. This is shown in table 5.7 that its p-
value is > 5%.
Having reported all governance issue, this paper finds that all controlling variables
except management ownership are significant in explaining company performance. Total
assets of company related negatively to company performance while outsider ownership (both
institutional and individual ownership) and leverage associate positively with performance
measured by Tobin’s Q.
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5.5. Summary
To conclude, this paper can find evidence for most of hypothesis posited in the
previous chapter. Indeed, there is relationship between board governance structure,
ownership, company size, leverage and company performance. Nonetheless, further
examination with simultaneous equation model must be done to detect endogenous problem
amongst variables and to seek the right model for the investigation relationship amongst these
variables.
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CHAPTER VI
DISCUSSION: IMPLICATIONS FOR INDONESIAN CORPORATE GOVERNANCE
The primary objective of this thesis was to investigate the effectiveness of corporate
governance in Indonesia. As defined in chapter one and chapter three, effectiveness is
compliance with the regulation and then, the compliance leads to a better company
performance.
6.1. Compliance of the JSX Companies with the Corporate Governance Regulation
Initially in chapter one, this paper presented some reports and studies showing
ineffectiveness of Indonesian corporate governance regulation. The JSX reports (2003) and
CGFRC-Standard & Poor’s (2004) show there were still companies which did not implement
the JSX corporate governance regulation. This study, as shown in the descriptive study, finds
there is an increasing awareness of companies to comply with corporate governance
regulation although there are still a few companies which still do not have independent
commissioners nor fulfil audit committee requirements. In spite of this increasing awareness,
the results show that companies are slow to meet the minimal requirements for compliance.
The findings of CGFRC-Standard & Poor’s (2004) reported in chapter 2 persist.
The late response of the JSX listed companies to comply with regulation further
indicates the weakness of legal system in Indonesia. Indeed, regulators have an important role
to impose the regulation so that market confidence increases. Penalties or sanction must be
given to those which do not comply with the regulation, otherwise the regulation is just the
same as moral suasion; the code of corporate governance practice is not compulsory but
voluntary.
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6.2. The Relationship between Company’s Compliance with Corporate Governance
and Company Performance
Turning to the effectiveness of the corporate governance practice on company
performance, the results of this paper generally show a favourable relationship between the
practice and performance. In contrast to the prior Indonesian regional study of Darmawati,
Khomsiyah, and Rahayu (2004), in general, this thesis found a support for compliance with
the attributes of board governance and their relationship to performance represented by
Tobin’s Q.
This paper supports a belief that independence is an important attribute, which can
improve company performance as shown by the findings of the paper. Board leadership and
the number of independent commissioners are significant to company performance. These
findings, in contrast with other studies as discussed in the literature review, supports the
theory of Berle and Means (1932) which suggests an independent director (commissioner, in
the Indonesian case) increases the effectiveness of monitoring and strategic planning role of
the board (Farrar 2005). Hence, it leads to a better company performance. In spite of the
favourable implications of appointing independent commissioners for company performance,
this study could not find evidence to support theory suggesting board size is one of factors
which contributes to an effective board. Therefore, similar to previous studies (Beiner,
Drobetz, Schmid, and Zimmermann, 2004; Kula, 2005; and Adams and Mehran, 2005), this
study failed to detect a relationship between board size and company performance.
Regarding to the characteristics of the audit committee, the finding of this study
supports a belief that independence is a matter for audit committee (BRC, 1999; Dezoort, et.al
2002). However, one point which must be of concern according to the results is related to the
other compliance characteristics of a good audit committee: leadership structure and
accounting/financial qualification. Oddly, while theory (BRC, 1999; DeZoort et.al 2002)
73
suggests a positive relationship of this attribute to company performance, this study finds that
the performance of companies without these audit committee attributes is greater by 0.33
compared with a company which complies with the regulation. The question is why the
relationship according to the theory (BRC, 1999; DeZoort et.al 2002) could not be found.
Therefore, further evaluation such as a forensic audit must be carried out to seek whether
companies have implemented the audit committee requirement properly. On the other hand,
this result further suggests a condition that it might be the company, which does not
implement the regulation properly, leads to these results. Indeed, the audit committee is
ineffective; based on the observation, one of auditor could in charge in more than one
company. The regulator has concerned with this issue, therefore there is new regulation
forbidding an audit committee member or an auditor in charge in more than two companies
(Kompas, 2004).
Beyond, the significance of independent and accounting/financial attributes on audit
committees, the insignificant effect of the size of the committee suggests that the issue of
audit committee size is not as crucial as the other attributes issue which are independence,
accountability, and effectiveness.
74
CHAPTER VII
CONCLUSION AND RECOMMENDATIONS FOR FUTURE STUDIES
7.1. Development of the Study
This research attempted to examine corporate governance in Indonesia. Indeed, an
extensive literature review on the issue has been presented. The literature, having shown
inconclusive results, posits an endogenous problem in the study. Therefore, based on the
literature, this paper has proposed some possible research models. Furthermore, the models
have been formulated into a series of econometrics models, which are a logistic model, a
linear regression and a simultaneous equation model. Nonetheless, only part of the study,
which is the linear regression results, is addressed in this thesis. The rest of the model is still
under examination. Hence, the development of this corporate governance study in the future
will be a study that employs logistic and a simultaneous equation models.
7.2. Conclusions
The topic of corporate governance had not proliferated until the Asian financial crisis
and the phenomena of outrageous corporate collapses around the world. In the Indonesian
context, the concept has been of concern, as it is believed that corporate governance can assist
in recovering its economic stability following the devastation of the Asian financial crisis.
Indeed, a series of programs has been put into practice including establishment of corporate
governance institutions and releases of codes of corporate governance. Above all, the
assessment of the efficiency and effectiveness of the implementation is important. Following
five years implementation of the practice in the Jakarta Stock Exchange (JSX), it is essential
75
to evaluate whether the JSX companies keep on the right track of the corporate governance
principles.
The objective of this thesis was to examine the effectiveness of corporate governance
in Indonesia by investigating Indonesian publicly listed companies in the Jakarta Stock
Exchange (JSX). Based on the descriptive analysis, the study found that most of the listed
companies have complied with the corporate regulation. However, their compliance is
minimal as statistics show that firstly, on average the composition of independent
commissioners just equals the JSX requirement, 30%, while there are still companies which
have not appointed independent commissioners. Next, similar to the condition of compliance
with numbers on a board of commissioners, the total number of audit committee members is
three persons. There are still companies which do not have audit committee. Therefore, the
findings are similar to a previous study (CGFRC-Standard & Poor’s, 2004); there are still
companies which do not comply with the regulation of corporate governance.
In the part of this Indonesian corporate governance study, besides presenting the
descriptive analysis, this paper also attempts to answer whether there is relationship between
corporate governance practice and company performance. Indeed, the study finds that the
market company performance of the JSX companies, using Tobin’s Q as the proxy, has
increased smoothly even though the Tobin’s Q value is still less than 1. The study also finds
that board governance attributes, with the exception of except board size and audit committee
size, significantly relate with the Tobin’s Q measure of performance. Only the attributes of
audit committee leadership and financial/accounting literacy requirements, are negatively
associated with market company performance. As noted in the previous section, this suggests
ineffective of audit committees in JSX listed companies. In fact, if many audit committee,
members are in charge of the audit committee in more than two companies; this could lead to
an ineffective audit committee.
76
Finally, it can be concluded that the findings of this paper is different from a previous
Indonesian study (Darmawati, Khomsiyah, and Rahayu, 2004). The previous study failed to
detect any relationship between variables. It might be the different methodology caused the
different results. While the study of Darmawati, Khomsiyah, and Rahayu (2004) constructed a
government index, and applied it to evaluate the overall governance system, this study
examined the board governance variables individually.
7.3. Limitation and Suggestions for Future Studies
The objective of this thesis was to evaluate corporate governance practice in
Indonesian listed companies. Specifically, the relationship between the corporate governance
practice and company performance is investigated. Nonetheless, this paper only observed
limited periods which are 2002-2004. The limitation of the data and time were constraints.
Therefore, this paper does not address the results of the corporate governnace checklist. This
thesis does not address either the results of endogenous problem of the relationship among
corporate governance, ownership structure and company performance. In addition to these,
this thesis does not do robustness check, for example changing the company performance:
Tobin’s Q with other proxy which are ROA and ROE. The results, however, will be addressed
in another paper. Finally, this paper does not include ‘soft elements’ of corporate governance
such as the process in the board governance in its investigation. Therefore, a longer time
horison and an inclusion of ‘soft elements’ of corporate governance in the variables measured
might make the study more comprehensive.
77
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87
Appendix 1
Summary of Literature Review
No Authors Title Research Methods
1 Abdullah, S. N. Board Composition, CEO Duality and Performance among Malaysian Listed Companies
Secondary data which consists of: 1. The lists of companies are from the main board of the Kuala Lumpur Stock Exchange from 1994-1996. 2. Data of board independence, CEO duality, and firm performance are from companies’ annual report period 1994-1996 and from Kuala Lumpur Stock Exchange Annual Handbook.
2 Abbott, L.J., Park, Y. & Parker, S.
The Effects of Audit Committee Activity and Independence on Corporate Fraud
Secondary data from: 1. The fourth quarter Consolidated Fianancial Statements for Bank Holding Companies (from FR Y-9C) from the Federal Reserve Board. 2). Stock price and return from Center for Research in Security Prices (CRSP).
3 Adams, R. B. & Mehran, H. 2005
Corporate Performance, Board Structure and its Determinants in the Banking Industry
Secondary data from: 1. The fourth quarter Consolidated Fianancial Statements for Bank Holding Companies (from FR Y-9C) from the Federal Reserve Board. 2). Stock price and return from Center for Research in Security Prices (CRSP).
4 Adams, R. B. & Mehran, H. 2003
Is Corporate Governance Different for Bank Holding Companies?
Secondary data from: 1. The fourth quarter Consolidated Fianancial Statements for Bank Holding Companies (from FR Y-9C) from the Federal Reserve Board. 2). Stock price and return from Center for Research in Security Prices (CRSP).
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5 Barnhart, S. W. & Rosenstein, S. 1998
Board Composition, Managerial ownership, and Firm Performance: An Empirical Analysis
Secondary data which consists of : 1. Lists of 321 firms are from the 1990 Standard and Poor’s 500; 2. Financial statement data is from the Industrial Compustat tapes; 3. Corporate governance data is from Institutional Shareholder Services (ISS).
6 Beiner, S., Drobetz, W., Schmid, F. & Zimmermann, H. 2004
‘Is Board Size an Independent Corporate Governance Mechanism?’
Secondary data which consists of: 1. The list of 165 firms, from Swiss Performance Index. 2. Other data are from Datastream, Worldscope, Aktienfüher Schweiz
2002/2003 and the website of Finanz und Wirtschaft.
7 Bhagat, S. & Black, B. 2002 ‘The Non-Correlation Between Board Independence and Long-Term Firm Performance,’
Secondary data: 1. Database compiled by Institutional Shareholder Service (ISS) of 957 large U.S. public corporateions. 2. Stock price data from Center for Research in Security Prices (CRSP). 3. Proxy statementsfrom LEXIS/NEXIS. 4. Compustat for Accounting performance
8 Black, B.S., Jang, H. & Kim,W. 2006
‘Does Corporate Governance Affect Firm Value?’
Primary data: Survey of corporate governance practices by the Korea Stock Exchange (KSE); Secondary data: from the TS2000 database maintained by the Korea Listed Companies Association (for balance sheet, income statement, and industry data); the Korean Fair Trade Commission (the list of companies affiliated with the top-30 chaebol); a KSE database (stock market and share ownership data); information on ADRs from JP Morgan and Citibank websites; Korea Statistics Office (industry classifications).
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9 Brown, L.D. & Caylor, M. L. 2005a
‘Corporate Governance and Firm Operating Performance,’
Secondary data: Corporate governance data were obtained from Institutional Shareholder Services . Firm performance data were obtained from Compustat.
10 Brown, L.D. & Caylor, M. L. 2005b
‘Corporate Governance and Firm Performance,’
Secondary data: Corporate governance data were obtained from Institutional Shareholder Services . Firm performance data were obtained from Compustat.
11 Carter, D. A., Simkins, B. J. & Simpson, W. G. 2003,
‘Corporate Governance, Board Diversity, and Firm Value,’
Secondary data which consists of: 1. The company lists, from Fortune 1000 firms. 2. Data on board of director characteristics for 1997, from Directorship’s board
of director database, issued by Directorship (a corporate governance consulting organisation).
3. COMPUSTAT database (for companies’ accounting data)
12 Coles, J.W., et.al An Examination of the Relationship of Governance Mechanism to Performance
Secondary data: the Jensen and Murphy executive compensation database; The Stern Stewart Perforamnce 1000 database (for EVA and MVA); Q-file (Firm Proxy Statements); Compustat database
13 Chhaochharia, V. and Grinstein, Y.
Corporate Governance and Firm Value-the Impact og the 2002 Governance Rules
Secondary data: the Center for Research in Security Prices (CRSP) database and the Compustat database (for financial data); the Investor Responsibility Research Center (IRRC) (for board structure infornation); the Auditor Track database of Stafford Publications Inc, SEC filings of US public corporations (for auditor changes-data)
14 Darmawati, D., Khomsiyah & Rahayu, R. G. 2004
The Relationship Between Corporate Governance and Company’s Performance,
1. Secondary data of listed companies in Jakarta Stock Exchange. 2. Sample taken based on purposive sampling of IICG institute, total sample are
53 companies, pooled data for year 2001 and 2002 (21 companies from year
90
2001 and 32 companies from year 2002). 3. The corporate governance implementation data, formed as Corporate
Governance Perception Index (CGPI), taken from 2001 and 2002 IICG survey. 4.Financial data and stock market data taken from Indonesian Capital Market Directory 2003.
15 Davidson III, W.N., Xie, B. & Xu, W. 2004
‘Market Reaction to Voluntary Announcements of Audit Committee Appointments: the Effect of Financial Expertise,’
Seconcary data from Lexis/Nexis business news library and Center for Research in Security Prices (CRSP) database.
16 DeAndreas, P., Azofra, V. & Lopez, F. 2005
‘Corporate Boards in OECD Countries: Size, Composition, Functioning and Effectiveness,’
Secondary data which consists of: 1. Data of the role of board directors, board size, board composition, board meeting, and board compensation is taken from Spencer Stuart Board Index. 2. Financial data is taken from Global Vantage Database and Standard and Poors.
17 DeFond, M.L., Hann, R.N. & Hu, X. 2005
‘Does the Market Value Financial Expertise on Audit Committee of Boards of Directors?’
Secondary data: the 2002/2003 Corporate Library Database; the Lexis/Nexis retrieval system (for Company press announcements)
18 DeZoort, F. T. & Salterio, S. E 2001
‘The Effects of Corporate Governance Experience and Financial-Reporting and Audit Knowledge on Audit Committee Members' Judgments,’
Mail questionnaires/survey (sent to 340 Canadian companies; response rate: 20%)
19 DeZoort, F. T., Hermanson, D.R, Archambeault, D.S., & Reed, S.A. 2002
‘Audit committee effectiveness: A Synthesis of the Empirical Audit Committee Literature,’
Literature review
20 Evans, J., Evans, R. & Loh, S. 2002
‘Corporate Governance and Declining Firm Performance,’
Secondary data from Datastream, Connect 4, Global Access Database and Company Analysis
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21 Farinha, J. 2003 Corporate Governance: A Survey of the Literature,’ A survey of literature
22 Firth, M., Fung, P.M.Y., and Rui, O.M.
Simultaneous Relationship among Ownership, Corporate Governance, and Financial Performance
Secondary data: Annual Report over three-year period 1998-2000; the China Stock Exchange Market & Accounting Research Database
23 Gillan, S. L., Hartzell, J. C & Starks, L.T 2003
‘Explaining Corporate Governance: Boards, Bylaws, and Charter Provisions,’
Secondary data: the Investor Responsibility Research Center (for board data and information on charter provisions); Compustat (for firm characteristics); Execucomp (for compensation data); Thomson Financial (for institutional ownership data); CThe Center for Research in Security Prices (CRSP) (for return data)
24 Gompers, P.A., Ishii, J.L., & Metrick, A. 2003
‘Corporate Governance and Equity Prices,’
Secondary data consists of: Information on 24 different corporate-governance provisions for an average of 1,500 firms per year from September 1990 to December 1999, Corporate governance at the firm level, from: 1. Publications of the Investor Responsibility Research Center (IRRC). 2. The Center for Research in Security Prices (CRSP) 3. Standard and Poor’s Compustat database.
25 Hermalin, B. E., & Weisbach, M. S. 2003
‘Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature’
A survey of economic literature
26 Hutchinson, M.
An Analysis of the Association between Firms' Investment Opportunities, Board composition, and Firm Performance
Secondary data: the Australian Stock Exchange; Connect 4: An Australian database of 200firms in terrms of market capitalisation
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27 Hung, H. 1998, ‘A Typology of the Theories of the Roles of Governing Boards’, Literture review
28 Hyland, M. M. & Marcellino, P. A., 2002
‘Examining Gender on Corporate Boards: A Regional Study’
Secondary data consists of 10-K fillings from government fillings.
29 Iskander, M.R. & Chamlou, N. 2000
Corporate Governance: A Framework for Implementation, Overview
Secondary data of proxy statements from CDA/Wiesenberger.
30 Johnson, S., Boone, P., Breach, A. & Friedman, E. 2000
‘Corporate Governance in the Asian Financial Crisis,’
Secondary data from the International Finance Corporation's Investable Index (published in the IFC's 1998 and 1999 Emerging Markets Factbook and updated daily in the Financial Times), J.P. Morgan (Emerging Markets: Economic Indicators, Dec. 5, 1997), Goldman Sachs (Emerging Markets Biweekly), and International Country Risk Services,
31 Klein, A. 2000 ‘Audit Committee, Board of Director Characteristics, and Earnings Management,’
Seconday data: 1). SEC-filed proxy statements. 2). Compustat and Center for Research in Security Prices (CRSP) database
32 Krishnan, J. 2005 ‘Audit committee quality and internal control: an empirical analysis,’
Secondary data from 1). SEC's Edgar database (disclosure Inc.database) 2). Lexis/Nexis database 3). Compustat database
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33 Kiel, G. C. & Nicholson, G. J. 2003
‘Board Composition and Corporate Performance: How the Australian Experience Informs Contrasting Theories of Corporate Governance,’
The secondary data which contains of: 1. The list of companies, based on trading information of Stock Exchange Limited (ASX) in 1996. 2. The companies’ data and the list of board of directors, collected from the 11th edition of Huntley’s Shareholders: The handbook of Australian Public Companies (Huntley’s financial database) and the Business Who’s Who in Australia.
34 Klapper, L. F. & Love, I. 2004
‘Corporate Governance, Investor Protection and Performance in Emerging Markets,’
Secondary data of: 1). results of questioners (Corporate Governance Index) completed by CLSA (Credit Lyonnais Analysts); 2). Accounting Data fromWorldscope data (2001)
35 Korac-Kakabadse, N., Kakabadse, A. K. & Kouzmin, A. 2001
‘Board Governance and Company Performance: Any Correlation?’,
Literature review
36 Kula, V. 2005
‘The Impact of the Roles, Structure and Process of Boards on Firm Performance: Evidence from Turkey’,
Primary data: Survey methods -questionnaires (return rate: 82.9%)
37 Mangena, M. & Pike, R. 2005
‘The Effect of Audit Committee Shareholding, Financial Expertise and Size on Interim Financial Disclosures,’
Secondary data of : 1). Lists of 262 companies from Waterlow Stock Exchange Yearbook 2002. 2). Interim and annual reports collected from each companies
38 Nam, S. & Nam, I.C., 2005
‘Corporate Governance Reform in Asia,’ Corporate Governance In Asia: Recent Evidence from Indonesia, Republicly of Korea, Malaysia, and Thailand,
Questionnaire surveys (mail) of 307 countries in total, from four countries.Response rate are 59% (Indonesia), 52% (Thailand) and 29% (Korea)
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39 Rezaee, Z., Oibe, K. O., & Minmier, G. 2003
‘Improving Corporate Governance: the Role of Audit Committee Disclosures,’
Secondary data of audit committee from company's proxy statements.
40 Shleifer, A. & Vishny, R.W, 19962006.
A Survey of Corporate Governance’, Survey: open questions.
41
Standard & Poor’s and Corporate Governance and Financial Reporting Centre, NUS Business School, National University of Singapore.
Corporate Governance Disclosures in Indonesia: A study of LQ45 Companies.
1. Secondary data which consists of 42 companies’ annual report whose ending year December 31, 2002. 2. Assessment checklist based on CG scorecard reflecting principles and practices embodied in international corporate governance codes, suitably modified for the Indonesian environment.
42 Tabalujan, B. 2002
Family Capitalism and Corporate Governance of Family-controlled Listed Companies in Indonesia
Secondary data from Indonesian Capital Market Directory (ICMD)
43 Van den Berghe, L. A. A. & Levrau, A. 2004
Evaluating Boards of Directors: What Constitutes a Good Corporate Board?
Interview of 30 companies listed on Euronext Brussels and Nasdaq Europe.
44 Wan, D. & Ong, C. H. 2005
Board Structure, Process, and Performance: Evidence from Publicly-Listed Companies in Singapore
Mix of Primary and secondary data, which consists of: 1. The lists of publicly listed companies in Singapore, from the website of Singapore Exchange (the secondary data). 2. The transparency index of board, compiled from Business Times, Singapore’s
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news paper (the secondary data). 3. Data of board processes and board roles, based on survey with questionnaires (the primary data). The processes of questionnaire design are: a. Conduct face-to-face interviews with three industry representatives and four company directors. b. Develop the draft of questionnaire, based on the literature review and feedback of face-to-face interviews. c. Send the draft to two directors, expecting for comment. d. Do pilot surveys by mailing the survey to random respondents of 20 boards. 17 boards participated by returning the surveys. e. Mail the survey to remaining 407 boards. f. To increase the participate rate, the researcher sent out two survey reminders and made telephone
45 Williams, S.M. Corporate Governance and Intellectual Capital Archive
Secondary data: Annual reports of the companies and 2000 Singapore Stock Exchange (SGX)
46 Xie, B., Davidson III, W.N. & DaDalt, P.J. 2001
Earnings Management and Corporate Governance: The Roles of the Board and the Audit Committee
Secondary data of proxy statements from Compustat database
47 Zahra, S.A. & Pearce II, J. A. 1989
Board of Directors and Corporate Financial Performance: A Review and Integrative Model
Synthesis (review) of literature
