Corporate governance and firm performance

How is corporate governance measured? What is the relationship between corporate governance and performance? This paper sheds light on these questions while taking into account the endogeneity of the relationships among corporate governance, corporate performance, corporate capital structure, and corporate ownership structure. We make three additional contributions to the literature:First, we find that better governance as measured by the Gompers, Ishii, and Metrick [Gompers, P.A., Ishii, J.L., and Metrick, A., 2003, Corporate governance and equity prices, Quarterly Journal of Economics 118(1), 107–155.] and Bebchuk, Cohen and Ferrell [Bebchuk, L., Cohen, A., and Ferrell, A., 2004, What matters in corporate governance?, Working paper, Harvard Law School] indices, stock ownership of board members, and CEO-Chair separation is significantly positively correlated with better contemporaneous and subsequent operating performance.Second, contrary to claims in GIM and BCF, none of the governance measures are correlated with future stock market performance. In several instances inferences regarding the (stock market) performance and governance relationship do depend on whether or not one takes into account the endogenous nature of the relationship between governance and (stock market) performance.Third, given poor firm performance, the probability of disciplinary management turnover is positively correlated with stock ownership of board members, and board independence. However, better governed firms as measured by the GIM and BCF indices are less likely to experience disciplinary management turnover in spite of their poor performance.     

Corporate governance and firm operating performance

Using a unique dataset provided by Institutional Shareholder Services (ISS), we relate 51 governance provisions to firm operating performance as proxied by return on assets and return on equity. We identify six corporate governance provisions that are significantly and positively linked to return on assets, return on equity or both using at least two of our six regressions. We examine nine governance provisions that have been recently mandated by the three major U.S. stock exchanges, and we find none of them to be significantly and positively related to firm operating performance. Our results reveal that the governance provisions recently mandated by the U.S. stock exchanges are less closely linked to firm operating performance than are those not so mandated.

CEO compensation structure and firm performance

The objectives of our study are to estimate a model of ‘efficient’ compensation structure based on firm characteristics and test the performance consequences of deviation from the efficient compensation structure. Our results are based on 3503 firm years for the period from 1999 to 2005. The results suggest that firms whose CEOs receive compensation inconsistent with their firm characteristics have a lower performance compared to those firms whose CEOs’ compensation is consistent with their firms’ characteristics. Our measure of performance is based on both accounting and market‐based performance measures. Overall, our study provides some important new insights into the links between CEO compensation structure and firm performance.     

Disproportionate insider control and firm performance

The effect of disproportionate insider control on firm performance is ambiguous. Disproportionate control may enhance insiders’ ability to expropriate perquisites; on the other hand, it may provide stability of management and reduce short‐term market pressures. Using a hand‐collected sample of U.S. dual‐class firms, we find that disproportionate control is positively associated with accounting‐based performance, but negatively associated with Tobin's Q. These results are consistent with the incentives of entrenched insiders who are interested in profitability but less beholden to capital markets.     

Individual political contributions and firm performance

We present evidence that individuals make political contributions strategically by targeting politicians with power to affect their economic well-being. Individuals in Congressional districts with greater industry clustering choose to support politicians with jurisdiction over the industry. Importantly, individual political contributions are associated with improvements in operating performance of firms in industry clusters. The relation between contributions and firm performance is strongest for poorly performing firms, firms closer to financial distress, and for contributions in close elections. The results imply that individual political contributions are valuable to firms, especially during bad economic times.     

Public pension fund ownership and firm performance

Equity ownership by public pension funds (PPFs) is widely used in the literature (see, e.g., Cremers and Nair 2005; Dittmar and Mahrt-Smith 2007) as a measure of the strength of shareholder monitoring/governance. This paper raises caution on such practices by illustrating an inverted-U shape relationship between PPF ownership and firms’ future performance, measured by stock returns and operating performance: during 1985–2005, future performance first increases, then declines in aggregate equity ownership by PPFs. Our results suggest that PPFs’ presence is consistent with shareholder value maximization when they have moderate influence on firm management, whereas excessive PPF ownership may facilitate PPF managers’ pursuits of political interests and destroy shareholder value. Therefore, it is important to impose an upper bound to PPF ownership when measuring the strength of shareholder monitoring/governance.     

Auditor independence, executive pay and firm performance

This paper investigates whether compensation committees actively intervene to adjust accounting performance‐based incentive schemes for the real, or perceived, reduced earnings credibility signalled by the purchase of non‐audit services. Using a nonlinear, two‐stage least‐squares method that accounts for the simultaneity of executive pay, firm performance and non‐audit fees, we find a significant negative relationship between non‐audit fees and the sensitivity of chief executive officer (CEO) pay to firm performance. Point estimates suggest that the reduced weight applied to accounting performance lowers the incentive component of executive pay between roughly 5 and 8 per cent for the CEO of the ‘average firm’.     

Family ties,board compensation and firm performance

This study examines the effect of corporate boards with family ties on board compensation and firm performance. Family firms dominate the vast majority of enterprise forms around the world. Despite possible agency problems between large and small shareholders, family boards may contribute specific knowledge and competitive advantage to the firm. This paper shows that the excess board compensation of firms with a non-family CEO is positively related to the percentage of board members with family ties, but the presence of family boards cannot justify the outcome of firm performance, suggesting a negative entrenchment of firms with a non-family CEO. By contrast, the excess board compensation of firms with a family CEO is found to be unrelated to the percentage of board members with family ties, and the presence of family boards is positively associated with firm performance, suggesting the convergence-of-interests of firms with a family CEO.     

Business strategy,executive compensation and firm performance

We investigate the impact of business strategy on the use of performance‐linked compensation (PLC) and long‐term incentive plans. We also examine the relation between strategy and compensation structure fit and performance. Using cluster and content analyses to classify a firm’s business strategy, we predict and find that product differentiation firms use a higher proportion of PLCs than cost‐leadership firms. Furthermore, we find that the misfit between business strategy and compensation structure has a negative impact on performance. This study contributes to the executive compensation literature by recognizing that business strategy influences the compensation structure and that a strategy and compensation structure misfit negatively affects performance.     

Capital structure,equity ownership and firm performance

This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.     

State control,access to capital and firm performance

We study the effect of state control on capital allocation and investment in China, where the government screens prospective stock issuers. We find that state firms are more likely to obtain government approval to conduct seasoned equity offerings than non-state firms. Further, non-state firms exhibit greater sensitivities of subsequent investment and stock performance to regulatory decisions on stock issuances than state firms. Our work suggests that state control of capital access distorts resource allocation and impedes the growth of non-state firms. We also provide robust evidence that financial constraints cause underinvestment.     

Corporate performance and firm perception: The British experience

Previous academic research has presented a theoretical basis for a relationship between attributes of a firm's reputation and its financial performance. For the United States, researchers have analysed the correspondence between market and accounting based measures of US firm performance and external evaluators' perceptions of the qualitative attributes of US firms. In this study, expert surveys on the qualitative performance of British firms conducted by the British publication, the Economist, which are similar in content to surveys conducted by Fortune magazine for US firms, are used to determine the correspondence between qualitative and quantitative measures of British firms' performance. Results indicate that differences may exist between US and Britain in the use of qualitative survey data on a firm's strategic attributes as a forecast of a firm's future quantitative performance measures. Results also indicate that for small firms, certain qualitative factors (e.g. capacity to innovate) may be of greater importance in forecasting accounting and security market returns.     

The impact of geographic diversification on firm performance

This paper empirically examines the economic effects of both corporate industrial and geographic diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis, D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value. Journal of Finance, 57, 1951-1979], the costs of corporate diversification may outweigh the benefits of diversification. We find that geographically diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D expenditures create value for multi-segment global firms, but not for single-segment global firms. This result implies that there exists an interaction effect between industrial and geographic diversification. We also examine the effects of agency cost issues, as characterized by the diversification discount, on both industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-based compensation are associated with higher firm value than firms with low equity-based compensation. Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.     

On institutional ownership and firm performance: A disaggregated view

We study the relationship between institutional ownership and firm performance in Finland. A systems approach is employed to investigate the potential two-way causality between firm performance and ownership structure. Three-stage least squares estimation technique is used to solve for the systems. The evidence suggests an endogeneity problem between firm performance and institutional ownership. However, the magnitude of the problem differs with respect to the concentration of ownership measure used. Our results show that a more equal distribution of the voting power among the largest institutional stakeholder may exert positive effects on firm performance. We also find a significant difference relating to firm performances and equity ownerships between the two classes of institutional investor. Consistent with the ownership structure in Finland, we find that a simple ownership concentration index does not influence firm performance.     

Globalization discourses and performance measurement systems in a multinational firm

This paper examines the role of management control systems, in particular performance measurement systems (PMSs) such as the Balanced Scorecard and key performance indicators, in a multinational context. We begin by exploring how globalization discourses are engaged with, consumed, appropriated, re-produced, disseminated and promoted in a major multinational company. We link the adaptation and dissemination of global discourses of senior managers with Said’s (1975/1997) concepts of authority and molestation. We then examine how PMS are translated and customized within local manufacturing plants and sales units in the UK and China, the significance of benchmarking and the extent to which PMS render managerial discourses of globalization practical. We comment on the importance of discourse in understanding control systems in general and the way in which external discourses impact the internal practices of the organization. We also explore some of the sources that give rise to molestation (deviation of practice from global aspirations of senior managers). We conclude by stressing the potential for the globalizing effects of PMS through the interaction of the discourses of HQ and subunits, even in the absence of explicit statements about globalization.     

Enterprise risk management and firm performance: The Italian case

This paper investigates whether a relationship exists between the extent of implementation of enterprise risk management (ERM) systems and the performance of Italian listed companies. While many contributions in the literature focus on the determinants of ERM adoption and use one-dimensional feature to proxy for ERM implementation, we detect the consequences of ERM implementation and capture a variety of features to measure the sophistication of the ERM system. The results show that firms with advanced levels of ERM implementation present higher performance, both as financial performance and market evaluation. Additional tests also corroborate the expectation that effective ERM systems lead to higher performance by reducing risk exposure and that reverse causality between ERM and performance is not present in the short term. The study provides a twofold contribution to the ERM literature. First, it introduces new and more complete measures for ERM implementation, concerning not only corporate governance bodies dedicated to risk management, but also the characteristics of the risk assessment process. Moreover, it provides evidence of a positive relationship between ERM implementation and firm performance in an under-investigated context such as Italy.     

Partisan political connections,ethnic tribalism,and firm performance

Review of Quantitative Finance and Accounting - This paper investigates the impact of partisan political connections and ethnic tribalism on firm performance in a hyper-partisan political...     

Enterprise risk management and firm performance: A contingency perspective

In recent years, a paradigm shift has occurred regarding the way organizations view risk management. Instead of looking at risk management from a silo-based perspective, the trend is to take a holistic view of risk management. This holistic approach toward managing an organization’s risk is commonly referred to as enterprise risk management (ERM). Indeed, there is growing support for the general argument that organizations will improve their performance by employing the ERM concept. The basic argument presented in this paper is that the relation between ERM and firm performance is contingent upon the appropriate match between ERM and the following five factors affecting a firm: environmental uncertainty, industry competition, firm size, firm complexity, and board of directors’ monitoring. Based on a sample of 112 US firms that disclose the implementation of their ERM activities within their 10Ks and 10Qs filed with the US Securities and Exchange Commission, empirical evidence confirms the above basic argument. The implication of these findings is that firms should consider the implementation of an ERM system in conjunction with contextual variables surrounding the firm.     

Executive pay dispersion,corporate governance,and firm performance

Much of the research on management compensation focuses on the level and structure of executives’ pay. In this study, we examine a compensation element that has not received so far considerable research attention—the dispersion of compensation across managers—and its impact on firm performance. We examine the implications of two theoretical models dealing with pay dispersion—tournament versus equity fairness. Tournament theory stipulates that a large pay dispersion provides strong incentives to highly qualified managers, leading to higher efforts and improved enterprise performance, while arguments for equity fairness suggest that greater pay dispersion increases envy and dysfunctional behavior among team members, adversely affecting performance. Consistent with tournament theory, we find that firm performance, measured by either Tobin’s Q or stock performance, is positively associated with the dispersion of management compensation. We also document that the positive association between firm performance and pay dispersion is stronger in firms with high agency costs related to managerial discretion. Furthermore, effective corporate governance, especially high board independence, strengthens the positive association between firm performance and pay dispersion. Our findings thus add to the compensation literature a potentially important dimension: managerial pay dispersion.

Stock market liberalization and operating performance at the firm level

I use firm-specific measures of openness to foreign investors to study the impact of stock market liberalization on firm-level operating performance. In a sample of over 1,100 firms from 28 countries, firms with stocks that are open to foreign investors experience higher growth, greater investment, greater profitability, greater efficiency, and lower leverage. Strategies to address potential endogeneity suggest that the observed relation reflects, at least in part, a causal effect of openness on operating performance.