DOES CORPORATE GOVERNANCE ENHANCE FIRM

PERFORMANCE?: AN EMPIRICAL LITERATURE EVIDENCE

Ronald Chibuike Iwu-Egwuonwu PhD

Part-Time Lecturer, University of Abuja, Nigera
& Managing Partner Stride Associates Consulting, Nigeria
owenbrucelyn@yahoo.co.uk
Tel: +234 8060945473, 08023013770

Abstract
This paper is a review of the empirical literature evidence on whether corporate
governance actually enhances firm performance. The notional view is that the quality of
performance of firms very much depends on the quality of their corporate governance. By
this view it is believed that without good governance no firm can do well and when firms
dont do well their contribution to the economic development of their nations would
either diminish or become zero.

This work finds that there appears not to exist, among current empirical literature, what
can amount to a consensus on whether corporate governance, as a cluster of values, does
indeed positively affect firm performance. What is certain is that some values of
corporate governance have individually been associated with high firm performance by
some studies. Most empirical research reports emanating from the U.S, for example, find
no consistent relationship between corporate governance and firm performance, while
similar studies in Asia report a convincing relationship between good corporate
governance and firm performance.

This paper assumes that the findings gap may narrow if research on this subject matter is
seen to be culture-bound and this can better explain the findings gap.

Key words
Corporate governance, firm performance, independent directors, minimized
accountability, corporate malfeasance, corporate scandals, key elements of corporate
governance,

Electronic copy available at: http://ssrn.com/abstract=1653921

Introduction:

Nations thrive on the performance of their economic units the major part of which are
business firms that operate in their corporate jurisdictions. The quality of performance of
these firms is of great interest to governments because by them a great amount of the
degree of economic development seen in a country is achieved. Governments fund their
annual budgets to a great extend by the amount of proceeds that come from internally
generated revenues a good part of which come from firms and corporations in the form of
tax and other forms of direct and indirect support. These firms also support quite a lot of
developmental projects in the country in line with their social responsibility goals. They
are able to do these things when they do well themselves. But to do well firms must by
themselves be governed well. The notional view therefore is that the quality of
performance of firms very much depends on the quality of their corporate governance. It
is believed that without good governance no firm can do well and when firms dont do
well their contribution to the economic development of the nation would be zero.

Notwithstanding that good governance has been a long time issue in public and corporate
governance, today there is a very strong interest in corporate governance, and this interest
is driven by the frequency of high profile corporate scandals beginning with those of
Enron, WorldCom, Royal Trust, Parmallat, and so on. In Nigerias banking industry
alone, about 54 banks failed between 1994 and 2005. This figure is quite scandalous and
disturbing and has thus helped to heighten overall interest in the improvement of the
quality of corporate governance. The role of the board as their firms collapse or get into
scandals overnight has also been quite disturbing. Just like it takes many years to
become rich overnight, it also takes quite a long time of cover-ups for a firm to get into
the negative spotlight on account of minimized accountability, internal malfeasance, and
all other forms of misdeeds, yet these often appear to happen in the very open eyes of the
board of directors without their noticing it or so it appears. In such cases the question
frequently asked is: where was the board of directors? Unfortunately, as Andrew Graham
quotes Peter Drucker to have noted, In every single business failure of a large company
in the last few decades, the board was the last to realize that things were going wrong.

Electronic copy available at: http://ssrn.com/abstract=1653921

What really accounts for this? Does it have to do with the quality of those appointed to
boards or is it part of a conspiracy with the management team within the notion of agency
problems?

For reasons that appear to suggest director ineptitude, quite a lot of regulations and re-
regulations, especially through codes of best practices have been spawned across
corporate jurisdictions around the world in order to save firms and investments in them
by strengthening the quality of corporate governance. But that the problem of minimized
accountability and all forms of ingenious corporate malfeasance involving managers and
directors keep increasing even with all the regulatory safeguards put in place across
continental divides suggests that the problems of corporate governance are not what can
easily be arrested with regulations. There is need to look deep into the mindset of
corporate managers and directors to find out the true problems why man must often allow
his weaknesses to overcome actions for the common good. If we look around, we can
effortlessly take an inventory of corporate directors who are inordinately rich within the
dreams of avarice, and they continue to superintend over the very organizations they have
consistently fleeced. The most recent case in the United States is Bernard Madoff who
ironically was also Chairman of NASDAQ. These problems have made not a few people
to wonder if corporate governance now has a different meaning and purpose from what it
was originally meant to be.

What is Corporate Governance?

The 1992 U.K Cadbury Committee defines corporate governance as the system by
which organizations are directed and controlled. The Federal Reserve Bank of
Richmond defines the subject as ...the framework by which a companys board of
directors and senior management establishes and pursues objectives while providing
effective separation of ownership and control. It includes the establishment and
maintenance of independent validation mechanisms within the organization that
ensure the reliability of the system of controls used by the board of directors to
monitor compliance with the adopted strategies and risk tolerance. But Andrew
Graham sees it as the exercise of authority, direction and control of an organization for
the purpose of ensuring that its (the organizations) purpose is achieved. Thus, Good

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 governance is about safeguarding the mission of the organization, establishing a values
framework, ensuring that sound management and risk practices are in place, holding
those under oversight to account and accounting to the broader public interest.
Therefore, good corporate governance is not only about high financial performance, it
is about high achievement and performance within the line of activities, purpose,
vision and mission of an organization. In this sense therefore, corporate governance is
not an exclusive preserve of profit-making organizations; it can be successfully
applied to public sector/nonprofit organizations to achieve public governance
objectives within the definition of best practice.

Governance addresses such questions as:

Who is in charge of what
Who sets the direction and the parameter within which the direction is to be
pursued
Who makes decision about what
Who sets performance indicators
Who monitors process and evaluates results
Who monitors the monitor; and
Who is accountable to whom for what

Good governance is built on:

Sound corporate Culture
Respect
Common vision
Common rules of the game
Evaluation and holding the right people to account
Adaptation and change

Key Elements of Corporate Governance

It is important we note that every company has its own corporate governance, and
although we hear and talk of best practice in governance, organizations apply what works

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for them. This is why styles of corporate governance in one firm may differ in another yet
all of them achieve high performance, their goals and best practice. In the same way,
what constitutes key elements of corporate governance may be firm-based such that they
may differ from firm to firm. In this regard, HSBC Living Business has offered what it
explains as the seven key elements of good corporate governance as follows:

Independence of directors
If the directors of a company are also the owners and/or their family members,
entrepreneurs appointed by friends, or individuals who are involved in the daily
management of the company, the board is in danger of being prejudiced in their
favor. Having a majority of non-executive independent directors will help avoid
prejudice and conflict of interest between the board and the management, thus
enabling independent judgment in the interest of the company and the likelihood
of better firm performance.

Separation of strategic planner role from operator role

For small companies that do not have a board of directors it is a good practice for
the strategic planner of the business to be different from the owner-operator
because it frees the latter from day-to-day operational duties, and enables him or
her to focus on the long-term, strategic business planning.

An exit strategy for company owners

Whether it is a succession plan for passing on a family business or a buy-sell
arrangement, it should be planned and agreed amongst parties concerned (e.g.
shareholders, family members) well in advance.

Reliable systems and procedures

Potential creditors feel more confident if they know that the company has reliable
systems and procedures in place. Such processes enable smaller SMEs to operate
in the owners absence (e.g. because of illness), and allow for smooth hand-over
to other parties.

Credible accounts

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 Even for the smallest SMEs, credible accounts enable the entrepreneur to know
what is going on in the business, while allowing lenders to accept the company as
reliable. For bigger businesses, cooking of accounts to paint a better performance
picture of the firm and to boost its stock market performance can hardly speak
well of corporate governance in that firm.

Key performance indicators

These indicators (e.g. financial strategy, marketing plan, product/operational goal)
are used for measuring the performance of the company, its management and
even the board of directors.

Remuneration and HR policies

Transparency in matters such as remuneration, incentives, discipline and
dismissal is essential for attracting good employees. It is especially important for
retaining non-family members in family businesses.

On the other hand, Jon Hartzell in his work titled Defining good corporate governance,
was able to distill eight elements of corporate governance from several concepts of the
subject, and these are:

A well-informed, energetic board of directors, with a majority of outside (one

hopes, independent) members, preferably compensated in company stock rather
than cash, and with the information resources and the confidence to give proper
direction to the CEO and other senior company management.

Transparent organizational structures and business processes, including, to the

extent possible, transparency in the corporate decision-making process. This can
be particularly important for officer and director selection and compensation.

Integrity of strategies, operating systems, and controls: things like formal bright
line policies, criteria, and guidelines, a comprehensive Management Information
System, a reliable process for management to detect, evaluate, and correct both

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 strategic and operational problems, a sound risk management approach, and a
strong internal audit program.

Full, accurate, and timely financial disclosure in conformity with Generally

Accepted Accounting Principles (GAP) or disclosure at least up to International
Accounting Standards.

A policy and record of corporate good citizenship confirming the companys

ethical and social awareness

A strong corporate governance culture, probably formally articulated in a

company statement of what we stand for and perhaps a code of corporate ethics.

A commitment to the creation and preservation of shareholder value with

various programs and benchmarks that enable measurement of progress (e.g.
ROA and ROE targets, operating cost ratio targets).

An appropriate level of responsiveness and accountability to shareholders, in the

form of, for example, some - but not disruptive - access for shareholders to
directors, and possibly to senior management, as well as opportunities for
meaningful shareholder participation in voting on company policies and
director/CEO selection.

The above discuss on definitional corporate governance is intended to take us into the
subject matter of this chapter which is whether good corporate governance assures high
firm performance. The focus of this chapter is thus not a full treatment of what should
normally come under introductory principles and practices of corporate governance.
Before we review the literature on empirical findings on the causal relationship between
measures of corporate governance and firm performance, let us first take some time to
review what firm performance really entails.

What is Firm Performance?

Performance can be seen here as the success in meeting pre-defined objectives, targets
and goals. Firm performance is thus the effectiveness of a firm in achieving the outcomes

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it intends to achieve within specified time targets. These outcomes can be explained as
the measures by which the firm is evaluated, and broadly include the quality of
governance. Governance quality of the firm is measurable by:

The quality of firm financial performance or attainment of high financial

performance goals.
The total valuation of the firm
Firm reputation
Firm Corporate Social Responsibility
Firms stock returns/share value
Ethical behavior of the firm
The technological asset through which it produces its product/services.
Board being controlled by more than 50% of independent outside directors
The board of directors having access to outside advisers.
Shareholder rights,
Transparency/information disclosure,
Board independence; and
Chairman Independence.
Legal protection of minority shareholder rights
Governance behavior
Observance of corporate governance standards
Compliance with codes of best practice
Ownership structure, and so on.

Although most firms tend to rely on the quality of their financial performance as evidence
of how well the firm has fared, in truth, to get a better picture of the total performance
and wellbeing of the firm, a combination of measures may be required. Some of these
measures are listed in bullet points above. One measure alone can be misleading. Take
the case of the defunct National Bank of Nigeria Plc, for example; the bank was still
showing some robust financial picture of its operational performance when that picture
was almost entirely based on the book value of totally dead loans. When a firm is

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successful on quite a number of performance measures, that firm can be described as
having achieved high performance. Our concern in this paper is to report empirical
research findings on whether there is a positive or negative correlation between different
measures of corporate governance and firm performance.

Empirical Literature Evidence on the Relationship between Corporate Governance

and Firm Performance

Bob Mcdowall would ask: does good corporate governance increase returns for
shareholders? Is there any correlation between the money invested in systems and other
mechanisms to provide the tools for good corporate governance and its output? Is
corporate governance like taking exercise: it makes you feel better but cannot be proved
to prolong your life? There have been a number of notional and empirical conclusions on
the question of whether corporate governance enhances corporate performance and
shareholder value. Some studies conclude that investors will appear to be willing to pay a
premium for companies with good corporate governance record but not that they derive a
greater return as a result of the good corporate governance. Some other studies have also
shown that companies with weaker shareholder rights did only marginally under-perform
against those with stronger shareholder rights; yet some other studies have also shown
that good corporate governance would appear to reduce volatility and some elements of
investment risks. There are also studies that show that good corporate governance
enhances corporate financial performance, firm stock market performance and
shareholder value, while some have also found no link at all between corporate
governance and firm performance. In some cases the results are mixed in one study. So, it
would appear that there is no general consensus or degree of certainty that corporate
governance pays. But the disparities noticed so far from research evidence on the effects
of good corporate governance on firm performance may just be as result of the fact that
corporate governance practices of firms are difficult to measure objectively since many
governance practices take place behind closed doors.

This sub-section of the paper reviews empirical evidence on the relationships that exist
between corporate governance and firm performance on most performance measures. The

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studies reviewed are here classified into three categories: those that establish positive
correlation between corporate governance and firm performance; those that find no such
relationships and those that find mixed relationships.

Some Studies That Establish Positive Correlation between Good Corporate

Governance and Firm Performance

1. On Investor Protection and Firm Performance in Emerging Markets

Empirical tests of a study by Leora F. Klapper and Inessa Love titled Corporate
Governance, Investor Protection, and Performance in Emerging Markets show that
better governance is highly correlated with better operating performance and market
valuation as measured by ROA and Tobins Q respectively. The authors also provide
evidence that firm-level corporate governance provisions matter more in countries with
weak legal environments. They also note that their results suggest that firms can partially
compensate for ineffective laws and enforcement by establishing good corporate
governance and providing credible investor protection. Finally, the authors add that their
tests also show that firm-level governance and performance is lower in countries with
weak legal environments. Their results suggest that firms in countries with poor investor
protection can use provisions in their charters to improve their corporate governance
which may improve their performance and valuation. This does not however imply that
firm-level corporate governance is a replacement for country-level judicial reform.

2. On CEO Duality/Separation of the Position of CEO from Board Chair

Another measure of good corporate governance is the separation of the roles of CEO
from that of the board chair. In this regard, Richard Bernstein, the Chief Strategist at
Merrill Lynch, in a 2004 study find that firms that have separate CEO and board chair
roles perform better than firms that combine both roles in what is also called CEO
duality. Bernsteins study thus confirms the widely held notion that firms that have
different people serving as chair and CEO respectively outperform those that concentrate
the two roles in one person.

3. On Board, Shareholdings and Ownership, as well as Disclosures and

Transparency

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Javed, Attiya Y. and Iqbal, Robina did a study in 2007 under the topic Relationship
between Corporate Governance Indicators and Firm Value: A Case Study of Karachi
Stock Exchange. The study investigates whether differences in the quality of firm-level
corporate governance can explain firm-level performance in a cross-section of firms
listed at the Karachi Stock Exchange. To accomplish their study, they analyzed the
relationship between firm-level value as measured by Tobins Q and total Corporate
Governance Index (CGI) and three other sub-indices identified as: Board, Shareholdings
and Ownership, as well as Disclosures and Transparency. The sample size was 50 firms
quoted on the Karachi Stock Exchange. Their result indicated a positive and significant
relationship between the quality of firm-level corporate governance and firm
performance. The likelihood of endogeneity problem was tackled in the study. The
authors further note that in general, the ownership and shareholders rights that align the
managers and shareholders interests are significantly valued by investors, and note that
the same applies for board composition and independence index. In other words, they
also find a significant positive correlation between board composition and board
independence with enhanced firm performance. The authors also find that corporate
governance code potentially improves the governance and decision making process of
firms listed on the Karachi Stock Exchange.

4), Stock Prices/Market Values and Board Independence

In their study which is the first to ever completely establish a causal relationship between
overall corporate governance measures or index and enhanced firm value, under the topic
Does Corporate Governance Predict Firms Market Values?, Bernard S. Black, Hasung
Jang and Woochan Kim find that good corporate governance is causally linked to higher
share prices in emerging markets. They also report their first empirical evidence that
show that board independence causally predicts higher share prices or firm value in
emerging markets. Black and his colleagues used in their study a corporate governance
index constructed for 515 Korean firms based on a 2001 Korea Stock Exchange survey.
This study is a very significant one given the fact that one of its authors, Bernard S. Black
who is a veteran in studies on corporate governance in relation to corporate performance,
has in the past consistently not found any association between corporate governance and

11
firm performance in developed countries especially as it concerns the causal impact of
independent directors on firm performance. In fact, in most of his studies on independent
directors, Black never found a positive correlation between independent boards and
enhanced firm performance. Curiously however, while his studies never established any
relationship between independent boards and firm performance in advanced countries
like the U.S, some studies in the emerging markets of Taiwan, Korea, China and Russia
establish such relationships. This prompted this writer to that studies on corporate
governance and firm performance may actually be culture-bound.

In another study Bernard S. Black, Inessa Love and Andrei Rachinsky in 2005 examined
the connection between firm-level governance of Russian firms and their market values
from 1999 to 2004, which was a period of dramatic change in Russian corporate
governance. Drawing on all six indices of Russian corporate governance in the study
titled Corporate Governance and Firms Market Values: Time Series Evidence from
Russia, the authors note that their finding strengthens the case for a causal association
between firm-level governance and firm market value. In fact, the present study by Black
and his team finds an economically important and statistically strong correlation
between governance and market value in OLS with firm clusters and in firm random
effects and firm fixed effects regressions.

Wolfgang Drobetz, Andreas Schillhofer and Heinz Zimmermann also did a study titled
Corporate Governance and Expected Stock Returns: Evidence from Germany in which
they explored the relationship between firm-level corporate governance and firm
performance using a sample of German firms. Referring to what they called a recent
empirical work that shows that a better legal environment leads to lower expected rates of
return in an international cross-section of countries, they structured their paper to
investigate whether differences in firm-specific corporate governance also helps to
explain expected returns in a cross-section of firms within a single jurisdiction. Their
study questionnaire includes 30 governance proxies divided into five categories as
follows:
Governance commitment
Shareholder rights

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 Transparency
Supervisory board matters; and
Auditing

For each of the 253 public firms surveyed from which 91 returned their completed
questionnaire, the answers gotten from the data analysis are aggregated to obtain a broad
corporate governance rating (CGR) which ranges from 0 (connoting worst corporate
governance) to 30 (connoting best corporate governance). With the Corporate
Governance Rating (CGR) constructed for these German firms to meet the objectives of
the study, the authors find a positive relationship between the CGR and firm value. They
finally state that an investment strategy that bought high-CGR firms and shorted low-
CGR firms would have earned abnormal returns of around 12 percent on an annual basis
during the sample period.

5). On General Firm-Level Corporate Governance

In yet another study, by Lawrence D. Brown and Marcus L. Caylor in 2004 titled
Corporate Governance and Firm Performance, the authors confirm that good corporate
governance positively correlates high firm value. To achieve the objectives of their study,
the authors created a broad measure of corporate governance, Gov-Score, based on a new
dataset provided by Institutional Shareholder Services (ISS). They explain Gov-Score as
a composite measure of 51 factors encompassing eight corporate governance categories
as follows: audit, board of directors, charter/bylaws, director education, executive and
director compensation, ownership, progressive practices, and state of incorporation. They
relate Gov-Score to operating performance, valuation, and shareholder payout for 2,327
firms, and find that better governed firms are relatively more profitable, more valuable,
and pay out more cash to their shareholders. The authors also examined which of the
eight categories underlying Gov-Score are most highly associated with firm performance
and show that good corporate governance, as measured using executive and director
compensation, is most highly associated with good performance. The eight categories
they examined are quality of audit, board of directors, charter/byelaws, director
education, executive and director compensation, ownership, progressive practices, and

13
state of incorporation. They also find that good governance, as measured using
charter/byelaws, is most highly associated with bad performance.

Brown and Caylor further underscore 13 factors they find to be most often associated
with good corporate performance as:
Attendance to board meetings by at least 75% of all board directors but that those
that did not attend had valid excuses for their absence
Board being controlled by more than 50% of independent outside directors
Nominating committee being independent
Governance committee meeting at least once a year
Board guidelines being in each proxy statement,
Option re-pricing not occurring in the preceding three years (i.e. last three years)
Option burn rate not being excessive
Option re-pricing is prohibited
Executives being subject to stock ownership guidelines
Directors not being subject to stock ownership guidelines
Existence of clear mandatory retirement age for directors
A regular review of the performance of board of directors, and
The board of directors having access to outside advisers.

In another swtudy, yvind Bhren, Bernt Arne degaard and Norges Bank on February
2004 report the results of their study titled Governance and performance revisited. The
authors used what they described as rich and accurate data from Oslo Stock Exchange
firms, to find that:
Corporate governance matters for economic performance,

Insider ownership matters the most,

outside ownership concentration destroys market value,

Direct ownership is superior to indirect ownership, and that

Performance decreases with increasing board size, leverage, dividend payout, and
the fraction of nonvoting shares.

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They note that these results persist across a wide range of singleequation models,
suggesting that governance mechanisms are independent and may be analyzed one by one
rather than as a bundle.

Another study by Vitaliy Zheka titled . Does Corporate Governance Causally Predict
Firms Performance? Panel Data and Instrumental Variables Evidence investigates the
impact of overall level as well as of separate elements of corporate governance on
enterprise performance for open joint-stock companies (OJSC) in a transitional economy
like Ukraine. To achieve the objective of the study, the authors sampled 5,000 Ukrainian
firms on the basis of their preferred governance practices between 2000 and 2002. They
also constructed overall index of Ukrainian Corporate Governance titled Ukraine
Corporate governance Index (UCGI) and sub-indices of corporate governance describing
such aspects of corporate governance as:
Shareholder rights,
Transparency/information disclosure,
Board independence; and
Chairman Independence

Two sets of instrumental variables are used by the authors to deal with econometric
problems that arise in the study. They use two-stage least squares (2SLS) estimator, and
two-stage generalized method of moments (2SGMM) estimator to account for arbitrary
heteroskedasticity. They took into account political diversity, religion (number of
Christian churches) and ethnic diversity across 24 regions in Ukraine. They also use time-
invariant variables plus time-varying religion variable as instruments after first
differencing transformation. Their results show strong evidence that corporate
governance predicts firm performance in a transition economy. They also document that
there are statistically and economically strong effects of shareholder rights, transparency
and board independence on performance. They conclude that firms with higher than
average levels of governance enjoy excessive improvement in their performance as
opposed to firms with lower level of governance.

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6). On Democratic Governance, Shareholder Rights and Equity Prices

Paul A. Gompers, Joy L. Ishii, and Andrew Metrick in their 2003 study titled Corporate
Governance and Equity Prices also underscore how the quality of corporate governance
affects firm value. The authors graded the level of shareholder rights of 1,500 U.S
incorporated firms for ten years, from September 1990 to December 1999, on a 1 to 24
scale. This period of study (1990 to 1999) was a period when the level of shareholder
rights began to vary among firms. A governance score of less than 5 was assigned to
firms with the strongest shareholder rights which were also seen as part of the
democratic portfolio. On the other hand, firms with the weakest shareholder rights were
assigned a score of 14 on the scale, and were also seen as part of the dictatorship
portfolio. They find that firms with strong shareholder rights yielded annual returns that
were 8.5% greater than those with weak rights. They also find that more democratic firms
enjoyed higher stock valuations, higher profits, higher sales growth, lower capital
expenditures, and made fewer corporate acquisitions. In fact, the study shows that the
democratic firms significantly outperformed those in the autocratic portfolio to the extent
that an investment of US$1 in the democratic portfolio on September 1, 1990, grew
annually to US$7.07 (23.3%) by 31 December 1999 while companies in the dictatorship
group only grew annually to US$3.39 (14%). The authors also show that there is a strong
correlation between corporate governance and financial valuations by finding that firms
in the democracy portfolio as measured by Tobins Q (i.e. the ratio of market value to
book value of assets) were 56% in points higher than those in the dictatorship portfolio
for 1999. They further report that for every one point increase in shareholder rights, a
firms value increased by 11.4%.

7). On the Effects of Country Legal System on Performance

Corporate Governance and the Returns on Investment is the title of a 2003 study by
Klaus Gugler, Dennis C. Mueller and B. Burcin Yurtoglu in which they show that the
origin of a countrys legal system proves to have the most important effect on corporate
performance. The authors analyze the impact of corporate governance institutions and
ownership structures on company returns on investment by using a sample of more than
19,000 companies from 61 countries across the world. They find that Companies in

16
countries with English-origin legal systems earn returns on investment that are at least as
large as their costs of capital while companies in all countries with civil law systems earn
on average returns on investment below their costs of capital. They further find that
differences in investment performance related to a countrys legal system dominate
differences related to ownership structure. The authors also present evidence that
managerial entrenchment worsens a companys investment performance .

8). On Legal Protection of Minority Shareholder Rights

Using a sample of 539 large firms from 27 wealthy countries, Rafael La Porta, Florencio
Lopez-de-Silanes, Andrei Schleifer and Robert Vishny in their 2002 study titled Investor
Protection and Corporate Valuation developed a model to measure the effects of legal
protection of minority shareholders and of cash-flow ownership by a controlling
shareholder on the valuation of firms. They report that consistent with their model, they
find evidence of higher valuation of firms in countries with better protection of minority
shareholders and in firms with higher cash-flow ownership by the controlling
shareholder.

9). On Measures of Governance Behavior

The Corporate Governance Behavior and Market Value of Russian Firms is the subject
of a 2001 study by Bernard Black of Stanford Law School. Black notes that in developed
countries, firm-level variation in corporate governance practices has a minor effect on
market value. In contrast, his work suggests that firm-level governance behavior has a
huge effect on market value in Russia. He further asserts that this finding for the Russian
market could well be true, perhaps to a lesser extent, in other governance-challenged
countries and it has the potential to be good news for firms in these countries. The result
suggests that firms can greatly improve their own share values, and thus reduce the cost
of raising equity capital, through a determined effort to improve their corporate
governance practices. It also suggests the potential value of minimum quality regulation,
which can reduce the potential for adverse selection and thus enhance all firms market
values. The author states that the evidence reported here on the correlation between
corporate governance behavior and firm value in Russia also has practical significance

17
for investors in Russian firms. The huge 700-fold difference in predicted value between
the worst and best ranked firms in his sample as reported in the results suggest that
investors should devote major attention to developing measures of governance behavior
and quantifying how governance actions affect firm value. Though he notes that the
results reported are tentative because of the small sample of the study he however
suggests that corporate governance behavior has a powerful effect on market value in a
country where legal and cultural constraints on corporate behavior are weak.

Some Studies That Find No Evidence that Good Corporate Governance Enhances
Firm Performance

i). On Impact of Corporate Governance Standards on Firm Performance

Carlos Pineda analyzes the relationship between firm performance, as measured by

Tobins Q, and the Corporate Governance Index published by The Globe and Mail
Report on Business for a sample of Canadian firms over a three-year period running from
2002 to 2004. The result of the study structured under the topic: Do Corporate
Governance Standards Impact on Firm Performance? Evidence from Canadian
Businesses, suggests that few measured governance variables are important and that the
effects depend to some degree on firm ownership. In general, Pineda finds no evidence
that a comprehensive measure of governance affects firm performance.

Working on the strict purpose of finding more insight into what type of measured
governance financial analysts and investors should take into account when selecting
stocks in Canada, Pineda extended the work done by Klein, Shapiro and Young in 2004
and analyzed the relationship between firm performance and Canadian Governance Index
(CGI) for a sample of Canadian firms between 2002 and 2004 (a period of three years).
He in addition used a pooled data in the analysis to establish the basis for more robust
results.

Overall, the author finds that board independence, which is the most heavily weighted
sub index in the CGI, has a negative effect on firm performance. He also notes that the
impact of governance practices on firm performance varies by ownership category and by
which governance practice is being measured. He states that the importance of

18
governance does not differ for family owned firms. More than this, he notes that
performance tends to be more positively related to shareholder rights and negatively with
disclosure procedures; and as a result the market accounts for a premium when it comes
to companies protecting shareholder rights but no recognition is accountable for firms
with better disclosure practices. In all, results from this study suggest that few
governance variables measured in the study are important and that the effects depend to
some degree on firm ownership. Finally, he finds no evidence that a comprehensive
measure of corporate governance affects firm performance.

ii). On the Effects of Corporate Governance, Especially Board Independence on

Performance
Peter Klein, Daniel M. Shapiro and Jeffrey Young studying Corporate Governance,
Family Ownership and Firm Value: The Canadian Evidence, analyze the relationship
between firm value, as measured by Tobins Q and some indices of effective corporate
governance. A total of 263 Canadian firms are sampled, and although the results show
that corporate governance matters in Canada, not all elements of measured governance
are important; the effects of governance on performance also differ by ownership
categories. Generally, among the 263 firms sampled, the authors find no evidence that a
total governance index affects firm performance. They explain that this result derives
from the fact that they find no evidence that board independence, the most heavily
weighted sub-governance index has any positive effect on firm performance. For family
owned firms they find that the effect of independent directors on corporate performance
is completely negative; this is notwithstanding the fact that sub-indices measuring
effective compensation, disclosure and shareholder rights practices enhance performance
for most ownership types of firms. They conclude by stating that they also find no
evidence that governance practices are endogenous.

Some Studies that Find Mixed Relationship between Good Corporate Governance
and Firm Performance

a). On Effects of Compliance with Codes of Best Practice

In their study titled An empirical analysis of the impact of corporate governance
mechanisms on the performance of UK firms, Charlie Weir, David Laing and Phillip J.

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McKnight analyze the extent to which a variety of monitoring mechanisms prescribed in
corporate governance codes, like the Cadbury Committee Report, affect corporate
performance. They note that in its Code of Best Practice, the Cadbury Committee
proposed a variety of monitoring mechanisms which, if implemented, should improve
corporate governance. They also assert that as part of the Code, it was recommended that
firms should have adequate non-executive director representation as well as appointing
an audit committee, the primary purpose of which is to monitor the auditing controls of
firms.

The study also analyzes the structure and caliber of audit committee membership and its
effect on the performance of 312 large UK quoted firms sampled for the study. Also
investigated, by means of take-over intensity by sector, is the effectiveness of the market
for corporate control. The authors find that neither the independence of the committee
membership nor the quality of the committee members has any effect on performance.
They however find that take-over intensity is negatively related to performance, thus
suggesting that external control mechanisms are more effective than internal ones. They
also report that when performance is split into deciles, there is some evidence that non-
executive director independence and the market for corporate control are substitute
governance mechanisms.

b). On Stock Returns, Firm Value and Performance

A study by Rob Bauer Nadja Gunster and Roger Otten, examines the Effect of
corporate governance on Stock Returns, Firm Value and Performance under the title
Empirical Evidence on Corporate Governance in Europe: The Effect on Stock Returns,
Firm Value and Performance. They analyze whether good corporate governance leads to
higher common stock returns and enhances firm value in Europe. Throughout the study
they use Deminor Corporate Governance Ratings for companies included in the FTSE
Eurotop 300 and following the approach of Paul A. Gompers, Joy L. Ishii, and Andrew
Metrick they build portfolios consisting of well-governed and poorly governed firms and
compare their performance. They also examine the impact of corporate governance on
firm valuation.

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Their results show a positive relationship between the variables and corporate governance
but this relationship weakens substantially after adjusting for country differences. Finally,
they analyze the relationship between corporate governance and firm performance, as
approximated by Net-Profit-Margin (NPM) and Return-on-Equity (ROE) but
surprisingly, and contrary to the conclusion of Gompers, Ishii, and Metrick they find a
negative relationship between governance standards and firm valuation, instead, they find
a stronger relationship between governance and firm value. The authors note that this
result is in line with prior empirical research which also demonstrate that the lower the
governance standards, the stronger the relationship between governance and firm value.

c). On the Effects of Ownership Structure on Corporate Governance

Jira Yammeesri, Sudhir C. Lodh, and Siriyama Kanthi Herath focus their study on
Influence of Ownership Structure and Corporate Performance: Evidence from
Thailand. The study examines the effect of ownership structure on corporate
performance of Thai non-financial firms between 1993 and 1996. The ownership
structure is considered as:
Concentrated ownership,
Different types of concentrated ownership and
Managerial ownership

The authors adopt Market Returns (MR) and accounting ratios as measures of
performance and report that there is a positive association between concentrated
ownership and firm performance. The results show that different types of concentrated
ownership have positive relationships to performance measures. However, the authors do
not find any evidence to support the existence of a non-linear relationship between
managerial ownership and firm performance.

Conclusion:

There appears not to be a consensus on whether corporate governance, as a cluster of

values, does indeed positively affect firm performance. What is certain is that some

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values of corporate governance have individually been associated with high firm
performance by some studies. Notionally, good corporate governance is said to assure
better firm performance, yet we notice that research findings in this regard appear to be
culture-bound. We have read research reports emanating from the U.S, for example,
which find no consistent relationship between corporate governance values and firm
performance, while similar research in Asia have reported a convincing relationship
between good corporate governance and firm performance. It is hoped that as research
continues on the subject matter, the findings gap will narrow to the point of
generalization across the world.

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