Corporate governance and financial performance : a study of companies listed on the Johannesburg Stock Exchange

Abstract

In the past two decades, corporate governance has received much attention from academics, investors and managers as well as from policymakers. This is mainly because of scandals and failures that have led to companies in a number of markets closing down. Even though fertile literature on corporate governance performance now exists, there has not been any consensus on the relationship between internal corporate governance and financial performance. In the main, the lack of congruence has been credited to inadequate estimation methods, endogeneity inherent in corporate governance studies, economic periods, industry nuances and country differences. Notwithstanding, the recent global financial crisis in 2007 to 2008 also heightened the interest in corporate governance. Proponents of corporate governance argue that the financial crisis was an exogenous shock that hit poorly governed companies more than their counterparts. On the other hand, critics of corporate governance attribute the global financial crisis squarely to corporate governance. Therefore, the main objective of the study was to understand the relationship between internal corporate governance and company performance from the perspective of three distinct economic periods as well as industry nuances, cognisant of endogeneity issues. Taking a cue from previous studies, the corporate governance attributes were board size, board independence, board committees, board diversity (in terms of race and gender), board activity and leadership structure. The dependent variable of the company was assessed by accounting-based measure (ROA) and market-based measure (Tobin's Q). The study used corporate governance fundamentals theories such as agency, resource dependence and stewardship to investigate the relationship between corporate governance and company performance. To this end, a sample of 90 companies from the five largest South African industries, namely basic materials, consumer goods, consumer services, financials and industrials covering a 13-year period from 2002 to 2014 (1 170 firm-year observations) were examined through the use of three estimation approaches, namely two-stage least squares (2SLS), generalised method of moments (GMM) and generalised least squares (GLS). Two important points emerged from the study. First, corporate governance structures operated differently in crisis and non-crisis periods. By and large, some corporate governance attributes had a positive impact on company performance during steady-state periods and provided a hedging mechanism during crisis periods. The results pointed to an important issue, which was the need to re-evaluate corporate governance not only in stable periods but also during turbulent times, and to evaluate its ability to perform effectively in such different conditions. Thus, crafting a robust corporate governance structure well in advance of the crisis could be helpful. Secondly, accounting returns appeared to be in favour of the stewardship theory, while market returns seemed to favour agency and resource dependence theories. This indicated that accounting returns viewed independent boards as adding no value while the market returns viewed independent boards as a means of bringing adequate resources to the company. Further, the market perceived larger boards, board activity, board committees and leadership structure to be structures that could provide adequate monitoring and reduce agency costs. The market presumed that managers were disingenuous and would embark on malpractices of personal embezzlement. This finding corroborated the empirical evidence of Black, Jang and Kim (2006:366), namely that insiders (managers) and outsiders (investors) valued corporate governance differently. Similar to most studies in corporate governance that recorded mixed results for accounting and market-based measures (Arora & Sharma, 2016:427; Gherghina, 2015:97; Meyer & De Wet, 2013:19), this study posited that it was not surprising that in some instances accounting-based and market-based performance measures provided contrasting results as the two indicators measured performance from different perspectives (Rebeiz, 2015:753). In respect of industry dynamics, findings from the regression results concluded that the relationship between corporate governance and company performance differed from industry to industry as well as from period to period and should not be replicated. For instance, in line with the stewardship theory and during the pre-crisis period, board independence had an inverse relationship to performance for the financials industry, which could imply that due to the nature and complexity of the financials industry, independent non-executives added no value as they did not understand the business better than executive management. These findings are important given the increasing trend towards boardroom independence around the globe. In this case, and contrary to King III, it would make sense to have more executive management members than independent board members. In the same vein, board independence had no impact whatsoever on the basic materials industry. Recently, a large body of empirical literature has raised questions about endogeneity making the findings of the relationship between corporate governance and performance spurious (Afrifa & Tauringana, 2015:730; Larcker & Rusticus, 2010:186; Nguyen, Locke & Reddy, 2014:2; Schultz, Tan & Walsh, 2010:146). The findings from a series of the sensitivity analyses indicated that the empirical evidence reported in this study was robust to potential endogeneity issues. The findings in the study have important implications for putting into practice good corporate governance. The outcomes of the analyses imply that South African companies may possibly enhance their performance by implementing good corporate governance practices based on their unique circumstances. However, the findings on the association between several governance indicators and company performance measures indicated that not all corporate governance attributes significantly affected company performance.