Internal Corporate Governance Mechanisms and the Performance of Financial Firms in the Context of the Recent Financial Crisis

Evidence from the UKby

Sardar Ahmad

Supervisors: Devendra Kodwani & Martin Upton

Outline

• Theoretical background• Research questions• Hypothesis• Methodology• Results and Findings• Questions and comments

Theoretical background• Agency Theory

• Separation of ownership and control leads to conflict of interests between shareholders and directors (Smith,1776, Berle and Means, 1932)

• Agency costs (Jensen and Meckling, 1976)

• Corporate Governance Mechanisms (Jensen, 1993)• Internal governance mechanism• External governance mechanisms

Internal corporate governance and firm performance: empirical evidence• In normal times:

– Positive association between internal corporate governance mechanisms and the performance of firms

(Core et al., 1999, Gompers et al., 2003, Brown and Caylor, 2006,Dahya and McConnell, 2007, Bebchuk et al.,2009, and Shabbir and Padgett, 2008 etc)

• In Extraordinary times:– Internal corporate governance mechanisms are associated with

a firm’s survival during crisis (Mitton, 2002, Graham and Narasimhan, 2004, Adams, 2009 etc)

Internal corporate governance and firm performance : empirical evidence

• Financial Firms:

– Different from non-financial firms (Adams and Mehran, 2003, John and Qian, 2003).

– Internal corporate governance and Performance• outside directors (Pathan, 2009, Adams and Mehran, 2010)• Size(Belkhir, 2009)

Research questions

• How does the level of compliance with the UK corporate governance code could affect the performance of financial firms during difficult economic times?

• How do internal corporate governance mechanisms affect the performance of financial firms in two economically different time periods?

Hypothesis

• The major hypothesis of the study is:

– There is a negative relationship between the level of non-compliance with the UK corporate governance code and firm performance in the period leading to recession (pre-2007), and in the period after the recession (post-2007)

Methodology

• Data– 76 financial firms (pre-2007) and 91 firms (post-2007)– Pre crisis period(2003-2006), Crisis Period (2007-2010)– Data sources :DataStream, Morningstar Company Intelligence

(Previously known as Hemscott Guru Database), Annual Reports

• Non-Compliance index (based on the provisions in section 1 of the UK Corporate governance code)– 0 for compliance with each provision– 1 for non compliance with each provision

Data and Variables• Independent Variables

– Non-Compliance index– Board of Directors (BODs) size– BODs composition– BODs Compensation– BODs ownership– Leverage (Debt to Assets)‒ Extra committees on board‒ Number of Internal control mechanisms in place‒ Average tenure of board members‒ Average age of board members

variables

• Dependent variables:

• Firm performance

–Tobin’s Q (total assets + market value of equity – book value of equity – deferred taxes) divided by total assets

• Total Shareholders Return (TSR)–Sum of capital gains and dividend yields

• Control Variables–Firm Size, Liquidity, Capital, Beta

Model

+

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Results

*Significant at .1 level, ** Significant at .05 level, *** Significant at .01 level 

Findings • Non-compliance with the UK corporate governance code

could have different implications for the performance of firms in different economic time periods.

• Non-compliance with the UK corporate governance code could lead to better performance in some cases (firms could be better off to adopt alternative corporate governance mechanisms)

• The relationship between individual corporate governance mechanisms and the performance of firms is affected by the overall economic conditions.

Implications• Investors- Non-compliance with the UK corporate

governance does not necessarily mean a bad thing.

• Regulators- Comply or explain system might be preferred than the rules based system.

• Companies- instead of complying with every provisions of the code they need to take into account organisational needs and the economic environment.

Thank you• Questions and comments

Sardar AhmadOUBSThe Open UniversityWalton HallMilton KeynesMK7 6AA

s.ahmad@open.ac.uk

www.open.ac.uk

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