IMPACT OF THE BOARD ON FINANCIAL PROFITABILITY The Case of Tunisian Companies

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ISSN 2321-645X
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Volume 4, Issue 8, August 2016
IMPACT OF THE BOARD ON FINANCIAL

PROFITABILITY The Case of Tunisian
companies
Mongi Gharsellaoui
High School of Business of Tunis, Manouba University-Tunisia
ABSTRACT
The aim of this study is to assess the impact of the Board on the financial profitability of Tunisian companies. Our present
research then tries to provide some answers to our question:"What is the impact of the Board on the financial profitability. To
answer this question, we examined a sample of 120 Tunisian companies. Our data is taken from the annual reports of each
company, the records of the Tunis Stock Exchange and documents of the Financial Market Council. Our results reject the
presence of a significantly positive impact of board size on financial profitability. However, we found that profitability resulted
from the good governance system of Tunisian companies. This finding is strong and essential, since we believe that good
governance is to guarantee a social equilibrium through rapid growth.
Key words: Board of Directors, External Directors, Accumulated Functions, Debt, Company Size, Turnover Growth.
1. INTRODUCTION
Corporate governance is believed to have important implications on the growth prospects of an economy. Good
corporate governance practices are considered important to reduce investor risk, attract investment capital and improve
business performance. According to Jensen (1993), the Board of Directors plays a fundamental role in corporate
governance as it is considered to be the first instrument or the most common mode used by shareholders to influence
managers behavior with a purpose of ensuring that the company is managed in the way that preserves their interest.
The concept of corporate governance has been extensively studied by many researchers following a series of scandals of
several large companies in the 1990-2000 period. Since then, governance mechanisms are questioned in a way to find
the causes of such scandals and the appropriate solutions for an effective control system that overcomes the weaknesses
of existing systems.
Likewise, the Board of Directors has been the subject of criticism whatever its role, function, efficiency and especially
its size. Indeed several questions can be raised, among which: does financial profitability depend on board size?
2. THE LITERATURE REVIEW

Several studies such as those of Changenti et al (1985) who suggest that smaller boards have a control function that is
much more important and effective despite the difficulties in coordinating their efforts. Jensen (1993) and Godard and
Schatt (2001) point to the magnitude of agency problems within companies and push managers to pursue their own
interests. According to Lipton and Lorsh (1992), a small Board size promotes the alignment of the interests of
managers with those of shareholders to improve corporate profitability. In this regard, Wu (2000) assumes that board
size creates problems of coordination and control between managers and investors and believe that smaller boards are
more efficient in controlling managers than large boards. Therefore, it is assumed that there is in a negative
relationship between board size and earnings management.
Several studies show that a small board size improves corporate performance, though it is true that additional directors
improve the control system but inversely they can slow down decision-making.
Jensen (1993) suggests that a small board plays an important role in the control function. However, with large boards,
there are difficulties in coordinating efforts. In this case, managers are free to set objectives. However, Townsend
(1970) and Geneen (1984) showed that the board is unnecessary because administrators do not have the ability to do
their job because managers dominate. Bedard and Chtourou (1998) assume that the board should consist of external
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directors to increase performance efficiency. In fact, all these factors are probably not the only ones to influence board
size. Managers dominance, ownership structure and firm size also seem to be important.
According to agency theory, a larger board size promotes manager control leading to conflicts between directors and
managers, between their coalitions and factions.
According to Yermack (1996) and Pichard-Stamford (1998), a large size is a favorable environment to establish a
conflicting and an uncertain climate, thus resulting in fragmented boards inefficient, a hidden rooting mechanism.
Similarly, Weisbach (1998) Byrad and Hickman (1992) and Borokhovich et al (1996), the larger the board is large the
more intense agency problems are, because board members bear on the intensity of agency problems in the firm.
In general, the statutory codes of a company or a bank can freely set number of administrators; the law leaves a
maneuver for companies to choose board size.
We can consider the board as a tool to enhance experience and knowledge to manage well diversification. According to
Pearce and Zahra (1992), a large board size gathers resources as companies pursuing a diversification strategy should
have a larger board of directors than companies pursuing specialized activities. The more a company has a large
number of directors the more it is diversified. Similarly, these authors show that a board that has a number of fairly
high administrators exerts more control over managers, limiting thus their opportunistic behavior. Consequently, a
company's diversification has a positive influence on board size. Dalton and Al (1999) also confirm that this positive
relationship is more intense for small businesses.
However, and according to agency theory, a large board size favors the dominance of directors by creating coalitions
and conflicts. Accordingly family businesses are eager to join the board and represent themselves in other groups of
shareholders. The result is that a few pwerful shareholders limit the choice of directors. Therefore, family businesses
have smaller boards, where such a concentrated ownership structure has a negative influence on Board size.
The relationship between profitability and board size was also put under scrutiny (members should serve on the board
of directors, the number of directors, coherence in the boards ....). Adams and Mehran (2003) note that banks with
large boards have higher performance than banks with small boards.
In some countries, like the US, it is assumed that a small board size positively affects profitability. Similarly, in
Tunisia, Mansi (2004) and Abdelwahab (2003) found that the small Board size positively affects firm performance.
Finally, manipulating directors performance is largely facilitated. It is obvious that size by itself does not exist, but an
adequate number of directors that brings together knowledge, abilities and skills in a relatively small group may insure
cohesion.
2.1 Board structure

In our study, we consider the structure of the board in terms of the percentage of outside directors in the total number of
board members. According to Godard and Schatt (1999), outside directors have a key role in ensuring efficiency of the
board as a control mechanism of managers that rallies the interests of the different stakeholders.
In this regard, several studies find that outside directors are more effective in controlling managers than inside directors
because these latter may be influenced by managers. In addition, Kaplan and Reishus (1990) and Rindavo (1999) found
a negative relationship between earnings management and the percentage of outside directors. Fama and Jensen (1982)
show that the presence of outside directors in the board is an important component since they strive essentially to
protect shareholders' interests. Similarly, Burd and Hickman (1992) suggest that outside directors are more efficient
than inside directors in controlling and disciplining managers.
2.2 Board Function
Several firms are known by conflicts of interests between shareholders and managers. This conflict will lead eventually
to higher agency costs and this will lead shareholders and directors to require a control system operated by the board.
Thus, this agency problem led theorists to investigate the role of the board in resolving these costs. In this case, outside
directors is indispensable. For this reason, the Board should encourage the leading role of outside directors in reducing
agency costs in cases where the decision-making process and control are separated, since outside directors are believed
to be more efficient than inside directors. Similarly, Dunn (1987) showed that outside directors limit the discretionary
behavior of managers allowing for the alignment of interests between managers and shareholders. Then, the board is
regarded as a main internal governance mechanism, because outside directors tend to control managers. Fama and
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Jensen (1983) called for a better protection of managers control so that this incentive enhances the reputation of
directors on the labor market and preserves their human capital. Bdard and Chtourou (1998) showed that outside
directors are more independent and are better placed than inside directors to control the CEO.
According to Fama and Jensen (1983), external members in the Board are particularly interesting because they strive
necessarily to protect shareholders interests. Similarly Fama (1980) suggests that managers may neutralize the Board,
and enter into conflicts with administrators. Thanks to external directors, disciplinary power would be saved, whose
independence is guaranteed by the competitive nature of market administrators.
Several other authors such as Weisbach (1988) and Pfeffer (1981) believe that internal directors are more efficient than
outside directors in terms of information. Rosenstein and Wyatt (1990) found that outside directors affect shareholder
wealth and can increase firm value. Similarly, Klein (1995) and Rindavo (2000) suggest that outside directors improve
firm performance. This finding was affirmed by Hermalin and Weisbach (2001) on the efficiency of the board and
pointed to an increase in firm performance following an increase in outside directors, since they are more efficient in
controlling leadership strategies.
3. The Research Model

In this section, we present the empirical approach we opted for to justify the use of panel data for our econometric
regressions. Then, we will present our equations and the various econometric tests we will use.
According to Hsiao (2003), recourse to the panel method rather than historical data provides more accurate estimates of
variables. Our study examines then a sample of 11 Tunisian banks observed over a period of 10 years. In fact, our study
aims to explain the dependent variable financial profitability (ROE). Bearing on previous empirical studies, we
consider the following specification:
ROEi,t = 0 + 1 Size-CAi,t+ 2 Ind-CAi,t + 3 Dual + 4 Levi,t + 5 Size-F + 6TCCA +i,t
with:
ROE: Financial profitability ratio or "Return on Equity".
Size-CAi,t : Represents board size measured by the number of directors.
Ind-CAi,t : Represents board independence. This variable is measured by the number of independent directors.
Dual: For managers rooting behaviour, we have retained a single variable which is the accumulation of functions of
CEO and Chairman of the Board. This is a dichotomous variable that takes 1 if the manager is himself
Chairman, 0 otherwise.
Levi,t : measures the level of indebtedness represented by the ratio of non-current liabilities and total assets.
Size-F : Represents firm size measured by the natural logarithm of total assets.
TCCA: turnover growth rate.
3.1 The Dependent Variables
The dependent variable is represented by return on equity (ROE). This variable is equal to the net profit of the bank by
total capital ratio.
3.2 The Independent variables
Referring to the empirical literature, we retain three variables that represent the board: board size (Size-CAi,t), board
independence (Ind-CAi,t) Accumulated functions of CEO and Chairman (Dual), debt level (Levi,t ), firm size (size-F)
and turnover growth rate (TCCA).
3.2.1 Board size (Size-CAi,t)
According to Bebchuk and Fried (2004) and Sapp (2007), large boards are considered less efficient and positively
influence executives compensation. This criterion reflects the number of directors on the board since these latter are
able to control mangers. Indeed, some countries set an optimal size while others choose a minimum or a maximum
size. Several authors like Dalton et al (1992) found a positive relationship between Board size and profitability.
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However, Yermack (1996) found a negative relationship between board size and profitability, as the presence of a
reduced number of directors increases managers layoff risk. Moreover, Lipton and Lorsh (1999) suggest that a large
board can be less efficient than a small one. The authors advocate a board size between 8 and 9 directors. The idea is
that when the board tends to be large, the agency problem increases and the board becomes more difficult to control,
and members will have difficulty expressing their opinions because of the limited time available for them during
meetings. According to Jensen (1993), boards with more than 7 or 8 directors are inefficient. Gillies and Leblanc
(2004) found that a size of 8 to 11 members is optimal. This variable is measured by the total number of directors on
the board.
Hypothesis 1: Board size positively affects firm profitability.
3.2.2 Board independence (Ind-CAi,t)
The presence of outside directors on the board enhances firm value as a source of pressure and control for managers.
positively affecting profitability. Independent directors are supposed to identify themselves with shareholders and use
their experience in decision-making and control to counteract tendencies of managers to make decisions for their own
interests and against those of shareholders.
Some authors like Beck et al (2004) showed that outside directors improve financial viability of firms. However, Pi and
Tienne (1993) found that board structure has no effect on profitability. This variable is measured by the percentage of
independent directors on the Board of Directors
Hypothesis 2 : The presence of outside directors on the board of directors has a favorable impact on firm profitability.
3.2.3 Accumulated functions of CEO and Chairman of the Board (Dual)
Pi and Timme (1993) found that accumulation of functions is often accompanied by low efficiency and profitability.
Such an assumption, as provided by agency theory, lies in the fact that the manager who is also the Chairman of the
Board will always protect his powerful position and makes less risky decisions. However, Fogelberg and Griffith (2000)
found no impact of combining functions on profitability. Finally, Boyd (1995) showed that the nature of the
relationship between function duality and profitability depends on the environment. This variable is a binary variable
that takes 1 if the CEO is also the Chairman, 0 otherwise.
Hypothesis 3: Accumulation of functions has a negative impact on firm profitability.
3.3 Control variables
The Board of Directors is not the only determinant of firm performance. The empirical literature highlights other
factors that may influence profitability. The control variables retained for this study are debt, company size and
turnover growth rate.
3.3.1 Indebtedness (Levi,t )
According to Buser (1981), setting the capital structure of a bank is similar to that of a non-financial company. Most
studies found a negative relationship between profitability and debt effect. In this regard, Titman and Wessels (1988)
argue that companies would maintain a relatively low level of debt. In addition, Kester (1986) and Rajan and Zingalas
(1995) found a significant negative relationship between profitability and debt ratios. However, some authors think
differently. These authors observed a positive relationship between profitability levels and debt. For example, Taub
(1975) and Abor (2005) found a significant positive relationship between debt and profitability. A companys debt ratio
is measured by the share of debt against total assets.
Hypothesis 4 : Debt has a positive impact on firm profitability.
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3.3.2 Company size (Size-F)
Firm size is used in several studies such as those of Mak and Ong (1999), Godard (2001) and Kwan (2003). The latter
found that company size has a significant and a positive effect on profitability and concluded to the existence of
economies of scale. In the same vein, Boyd and Runkle (1993), Pinteris (2002) and Adams and Mehran (2003) also
found that profitability is positively associated with bank size. Based on these results, this study assumes that size
positively influences bank profitability. This variable is measured by the natural logarithm of the value of the
company's total assets
Hypothesis 5: The relationship between firm size and profitability is positive.
3.3.3 Turnover growth rate (TCCA)
Turnover growth and profitability are both very essential to firms. However, there is no generalized relationship
between them. Different studies found different results, Jang and Park (2011) studied the relationship between
profitability and growth. They found that profit increases as turnover increases.
Hypothesis 6: Turnover growth rate has a positive impact on profitability.
Table 1: Descriptive Statistics
[1] Variable
s
[8] ROE
[15] SizeCAi,t
[22] Ind-CAi,t
[29] Dual
[36] Levi,t
[43] Size-F
[50] TCCA
[2] N
[3] Min
[4] Max
[5] Media
n
[6] Mean
[7] Std.Dev
[9] 120
[16] 120
[10] -0.621
[11] 0.352
[12] 0.124
[13] 0.089
[14] 0.146
[17] 5
[18] 12
[19] 12
[20] 8
[21] 1.456
[23] 120
[30] 120
[37] 120
[44] 120
[51] 120
[24] 0
[31] 0
[38] 0
[45] 17.235
[52] -10.115
[25] 0.421
[32] 0.723
[39] 0.632
[46] 27.695
[53] 32.897
[26] 0.152
[33] 0.78
[40] 0.281
[47] 27.107
[54] 12.584
[27] 0.176
[34] 0.654
[41] 0.305
[48] 24.167
[55] 11.265
[28] 0.109
[35] 0.098
[42] 0.073
[49] 0.487
[56] 6.002
In Table 1, we can see that:

Financial profitability (ROE) is at an average of about 8.90%, a maximum value of 35.20% and a minimum value
of -62.10%.
Average board size (Size-CA i, t) in the sample during the study period is 8 members with a maximum of 12
members and a minimum of 5 members. Similarly, examining board independence (Ind-CAi, t) we found that in
average 17.60% of the members are independent directors with a maximum value of 42.10%.
We see the combination of functions (Dual) is in average around 65.40% with a zero minimum value and a
maximum value of 72.30%.
Regarding the debt ratio (Levi, t), the average for all firms in our sample is 30.50%. The most indebted company
has a debt ratio of 63.20%.
The descriptive statistics also show that the average size (Size-F) of Tunisian firms is 24.167. The largest size is
27.695, while the smallest size is 17.235.
Turnover growth rate (TCCA) is in average 11.26% for companies with a maximum value of 32.97% and a
minimum value of 10,115%.
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4. The FIV Test and correlation matrix
According to Bourbonnais (2009), before starting the analysis, we should check for multicollinearity between the
independent variables to avoid error in the estimated regression coefficients. To this end, we use, first, the VIF test
(Variance Inflation Factors). This test tells us whether the correlation is acceptable by measuring the degree of increase
of the standard error due to correlation of variables with each other.
Table 2: Results of the VIF1 test on the variables
[57] Variabl
e
[58] SizeCAi,t
[59] IndCAi,t
[60] Dual
[61] Levi,t
[62] SizeF
[63] TCC
A
[64] VIF
Moyen
[65] VIF
[66] 1.34
[67] 1.28
[68] 1.26
[69] 1.72
[70] 1.38
[71] 1.30
[72] 1.38
From Table 2, we can see that all the independent variables have a VIF less than 4, the threshold recommended by
Evrard et al (2003) and Kennedy (1998). In the following, we calculate Spearmans correlation coefficients.
Multicollinearity exists when correlation between variables is high (above 0.7), as the studied constructs are often
linked.
2
: Typically, an acceptable VIF threshold, as recommended by Evrard et al, (2003), is 4. Moreover, Hamilton (1992) has shown that a range greater than
0.2 and less than 4 attest for a lack of multicollinearity.
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Table 3: Correlation Matrix

[73]
[80] SizeCAi,t
[87] Ind-CAi,t
[94] Dual
[101] Levi,t
[108] Size-F
[115] TCCA
[74] SizeCAi,t
[75] Ind-CAi,t
[76] Dual
[77] Levi,t
[78] Size-F
[79] TCCA
[81] 1
[82]
[83]
[84]
[85]
[86]
[88] -0.0987
[95] -0.0541
[102] 0.025
3
[109] 0.215
7
[116] 0.072
0
[89] 1
[96] -0.1123
[103] 0.088
4
[110] 0.165
7
[117] 0.075
4
[90]
[97] 1
[104] 0.521
4
[111] 0.079
8
[118] 0.1411
[91]
[98]
[92]
[99]
[93]
[100]
[106]
[107]
[113] 1
[114]
[120] 0.3226
[121] 1
[105] 1
[112] 0.158
9
[119] 0.201
8
From Table 3, the correlation matrix shows that all correlation coefficients are less than 0.7, a limit at which we usually
observe multicollinearity problems. This then indicates no multicollinearity between the independent variables included
in the model.
5. Presentation and interpretation of the regression results

5.1 Presentation of the results
The regression model presented above gave the results summarized in Table 4. The estimation method used is ordinary
least squares (OLS) in the absence of heteroscedasticity and auto-correlation between variables.
Table 4: Results of the panel datas linear regression

[122]
[143]
Variables
[123]
Coefficient
[124]
t-Statistic
[125]
Size-CAi,t
[126] - 0.0675
[127] -1.1251
[128]
Ind-CAi,t
[129] 0.2905
[130] 1.9987*
[131]
Dual
[132] 0.0411
[133] -1.0253
[134]
Levi,t
[135] - 0.9255
[136] -2.5897*
[137]
Size-F
[138] 0.0254
[140]
TCCA
[141] 0.0055
Constant
[144] 0.5789
[146]
R-squared
: 0.7426
squared : 0.7879
[147]
S.E. of regression : 0.03666
52.6767
[148]
Durbin-Watson stat : 0.5319
: 200
** Significant at the 5%,
[139] 5.5264**
[142] 3.0822*
*
[145] 3.3487
Adjusted RF-statistic
Observations
* Significant at the 10%
5.2 Interpretation of the results

The study of the impact of certain internal governance mechanisms on financial returns yielded the results shown in
Table 4 above:
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Board size (Size-CA i, t) is negative and insignificant. This result rejects the basic hypothesis that a larger board
makes the decision-making process easier and increases efficiency of financial communication.
The presence of outside directors in the board has a positive and a significant impact on the financial performance
of Tunisian companies. This result confirms our reserach hypothesis.
Accumulation of functions (Dual) has a positive and an insignificant coefficient. This result rejects our hypothesis.
Nevertheless, we see that the relationship between debt and return on equity is negative and significant at the 5%
level. This result shows that if debt increases, return on equity decreases. Our hypothesis which assumes a positive
impact on return on equity in Tunisian companies is therefore rejected.
Firm size (Size-F) has a positive and a significant coefficient. This result confirms our research hypothesis.
Turnover growth rate (TCCA) has a positive and a significant impact on return on equity in Tunisian companies at
the 1% level.
In the Board of Directors, regression model on profitability of Tunisian companies, the coefficient of determination
(linear adjustment coefficient) R2 is 0.7426. Therefore, the model explains 74.26%. Accordingly, our model has an
acceptable adjustment quality. This model is globally significant.
Table 5: Summary of regressions
[149] Dependent
variables
[152] Size-CAi,t
[155] Ind-CAi,t
[158] Dual
[161] Levi,t
[164] Size-F
[167] TCCA
[150] Hypothesis testing

[153] Hypothesis 1: Board size positively affects firm profitability.
[156] Hypothesis 2: The presence of outside directors in the board
of directors has a favorable impact on firm
profitability.
[159] Hypothesis 3: Accumulation of functions has a negative
impact on firm profitability.
[162] Hypothesis 4: Debt has a positive impact on firm
profitability.
[165] Hypothesis 5: The relationship between firm size and
profitability is positive.
[168] Hypothesis 6: Turnover growth rate has a positive impact on
profitability.
[151] Result
[154] not
significant
[157] Significan
t (+)
[160] not
significant
[163] Significan
t (-)
[166] Significan
t (+)
[169] Significan
t (+)
6. Conclusion
Our aim in this study is to empirically investigate the impact of the Board on the profitability of Tunisian companies.
According to the results, the studied boards are rather large. Their structure contains almost as many outside directors
as institutional administrators and a few foreign directors. However, the impact of Board size on corporate profitability
is negative. Furthermore, outside directors have a positive impact on return on equity. For the cumulative functions
dimension, our results show that this variable has a positive but an insignificant impact on profitability. However, the
hypothesis on corporate debt assuming a negative impact on the financial performance of Tunisian companies is
confirmed. As for the relationship between size of Tunisian companies and corporate profitability, we found a positive
and a significant impact. Therefore, the larger the size of the company is, the higher profitability is. Finally, we
concluded to a significant positive relationship between turnover growth rate and profitability of Tunisian companies.
In general, these mixed results lend themselves to a variation in measures and tools, samples and contexts.
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IMPACT OF THE BOARD ON FINANCIAL PROFITABILITY The Case of Tunisian Companies

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Volume 4, Issue 8, August 2016