1- Corporate Governance and Financial Performance ...

Corporate Governance and Financial Performance: Empirical Evidence from Public Listed Construction Companies in Malaysia Nazrul Hazizi Noordin IIUM Institute of Islamic Banking and Finance, Malaysia Salina Kassim IIUM Institute of Islamic Banking and Finance, Malaysia Abstract This study examines the relationship between corporate governance structures and financial performance by focusing on construction companies listed on the Kuala Lumpur Stock Exchange (KLSE). It applies a multiple regression analysis on data collected from annual reports of the companies for the years of 2009 and 2012. The corporate governance variables considered are board size, board independence role of duality, number of board meetings, existence of audit committee, existence of nomination committee, and existence of remuneration committee, while the financial performance of the listed companies is measured based on Tobin’s Q ratio. This study finds that there is a significant positive relationship between number of directors on the board and financial performance of listed construction companies. The results of this study indicate that construction firms have unique board characteristics that need a segregated corporate governance structure. Generally, the study is supportive of the view that enhanced corporate governance practices contributes towards increasing firm performance.

Keywords: Corporate governance, financial performance, Tobin’s Q

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1.

Introduction The key components of corporate governance are specifically designed to

overcome severe agency problems in modern corporations. Jensen and Meckling (1976) suggest that agency problems arise due to the separation of ownership and control which results in a potential conflict of interest between owners and managers. Managers who act in pursuit of self-interests are unlikely to maximize returns to shareholders as they tend to misuse corporate assets, through involvement in high risk or imprudent investment at the expense of capital providers (Shleifer & Vishny, 1986; John & Senbet, 1998). The conflict of interest may decrease firm’s value and distort corporate investment strategy (O’Connor & Rafferty, 2012; Denis & McConnell, 2003). In view of this, good corporate structures and policies are necessary to protect the interest of the shareholders and minimize the loss of firm value due to the separation of ownership and control. In Malaysia, the development of corporate governance is significant following the Asian financial crisis in 1997 in order to restore market confidence that was dented due to the crisis (Mohd Ghazali, 2010). Cheah (2010) highlighted that poor corporate governance is the major contributing factor that leads to the economic turmoil in 1997. The weak control over corporate governance includes less activities of reforming company structure, over-leveraging debts, lack of disclosures on transparency and accountability, and poor credit control systems (Alnasser, 2012). A survey jointly conducted by the Kuala Lumpur Stock Exchange (KLSE) and PricewaterhouseCoopers (PwC) Malaysia in 1998 showed that 94% of the respondents perceived that corporate governance reforms are important to enhance competitiveness and attractiveness of the home markets (KLSE & PwC, 1998). Thus, economic reforms through enhancement of the Malaysian corporate governance were necessary to reduce the impacts of the financial crisis, hence contributed to the resilience of the Malaysian corporate sector. In the specific context of construction companies, corporate governance structures are adopted to deal with increased competition for investment capital, globalisation and investor activism (Tait & Loosemore, 2012). Petrovic-Lazarevic & Djordjevic (2002) argue that governance in construction companies is different from the governance in other industries due to the nature of the industry itself, such as (i) -2-

physical characteristics of the product; (ii) statutory organization in the construction industry; and (iii) specific procedures in building and construction activities. The changing nature of the industrial structure and high rate of innovation in the construction industry has increased the potential severity of the agency problems, which then requires more attention on restructuring the corporate governance code (PetrovicLazarevic, 2003). For example, the shifting of production modes from labour-intensive to capital-intensive and to knowledge-intensive, advancements in information technology, and internalization of construction firms has forced business owners to hand-over a larger operational power to managers. Further, the frequent use of allotment shares as an incentive to improve the performance of management in construction projects may encourage managers to manipulate the company’s share prices to achieve personal gain. It appears that construction companies have more social and environmental responsibilities compared to other industries (Van Wyk & Chege, 2004). Coutinho and Macedo-Soares (2003) suggest that due to growing interest on business ethics, the organizational focus by construction companies is not only to satisfy stakeholders’ needs, but also providing a healthy and safe external environment. However, most large construction companies usually find what is perceived by the community differs from their actual aspiration and intention regarding social and environmental impacts (Purcell, 2003). Therefore, corporate governance is subjected to improve community perception on the organizational vision, hence increase financial performance and contribute to value creation and company’s growth. This study focuses on the construction industry as it has a major contribution to Malaysia’s rapid economic growth (Abu Bakar, Tabassi, Abdul Razak & Yusof, 2012; Yee Cheog & Mustaffa, 2010). The Construction Industry Development Board Malaysia’s (CIDB) reported that over the last 20 years, the construction industry has consistently contributed approximately 3% to 5% of the national Gross Domestic Product (GDP) and provides employment for about 10% of the total labour force (CIDB, 2009). Driven by the Economic Transformation Programme (ETP), the construction industry secured RM120 billion worth of projects in 2012, which surpassed the forecast of RM95 billion (Bahari, 2013). This represents a large amount -3-

of investments that requires greater investor protection through effective corporate governance policies. Despite the growing amount of investments, the construction companies in Malaysia are susceptible to high rate of corporate failures and bankruptcies (Yin, 2006). Besides, Abu Bakar (2006) warns for a possible downfall of the construction industry in 2020 to 2024 due to human resource crisis in Malaysia. This research brings more attention towards improving corporate governance of Malaysian construction firms to support the financial growth of the industry in the future. Therefore, this research aims to study the statistical relationship between corporate governance structures and the financial performance of the Malaysian listed construction companies in 2009 and 2012.

2.0 Corporate Governance: Concept and Its Relation with Financial Performance 2.1

Definition of Corporate Governance Economists apply an agency theory when defining corporate governance as set

of mechanisms used to induce executives and managers to make decisions that maximize the value to the owners of the company. For example, Shleifer and Vishny (1997) argue that corporate governance provides high level of assurance for suppliers of finance to secure a return on their investment. In the legal context, corporate governance may be seen as a set of rules that sustains and regulates the decision making process by the publicly traded corporations in relation to a public interest (Parkinson, 1993). Organizational sociologist, however, focus on the power and authority relationships within organization. For instance, in contemporary sociology, Davis (2005) proposed the “new directions of corporate governance” that refers to corporate governance as structures, processes and institutions used by organizations to exercise power and control resources. Developing a universal definition of corporate governance is difficult due to changes of market conditions and various market regulations in different countries. Every single country has unique market characteristics such as size, trend and competition in which corporate governance needs to be utilized to protect the investors. The Malaysian stock market consists of large number of family-owned businesses and -4-

state-owned enterprises, which is different to the US and European financial markets that are dominated by widely held companies (Claessens, Djankov & Lang, 2000). It is argued that the principle of corporate governance practised in developed countries like the US, UK and Australia may not be applicable in developing countries such as Malaysia (Liew, 2007). Therefore, it urges Malaysia’s SC to develop its own code of corporate governance that suits the characteristics of Malaysian listed companies and the local market circumstances. This research focuses on the implementation of corporate governance by construction companies in Malaysia. The Securities Commission (SC) Malaysia has provided a definition of corporate governance as follows (SC, 2012): “The process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long-term shareholder value, whilst taking into account the interests of other stakeholders.”

2.2

Relationship between Corporate Governance and Firm’s Financial

Performance Several empirical studies have been conducted to examine the relationship between good corporate governance and financial performance in Malaysia (Chang, 2004; Haniffa & Hudaib, 2006; Liew, 2007). Mathiesen (2002) suggests that corporate governance is a very important corporate mechanism, which is utilized by the firm owners to motivate the managers to generate a higher rate of return. The discussion on the importance of corporate governance is supported by Coombes and Watson (2000) who find that higher premiums are usually paid for the shares of good governance firms compared to poor governance firms in the emerging market. The payment of a higher premium indicates that firms with good corporate governance are able to yield higher price to book ratios. It is also found that moving from a poor governance structure to a good corporate governance structure increases the market value of the firm by approximately 12% (Newell & Wilson, 2002). The improvement in the market

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indicators such as share premiums and price to book ratios indicates that a significant correlation might exist between corporate governance and financial performance. The corporate governance are proxied by several variables. First, board size has often been highlighted as an indicator of corporate governance. Haniffa and Hudaib (2006) conducted an investigation on the relationship between corporate governance and financial performance of 347 listed Malaysian listed companies in between 1996 and 2000, find that board size has a significant negative relationship with Tobin’s Q. The research finding is supported by Ibrahim and Abdul Samad (2011) and Mak and Kusnadi (2005) who also find that reducing board size can improve the performance of public listed companies in Malaysia. Yermack (1996) suggests that companies with a small board of directors are more effective and efficient in performing their responsibilities than companies with a large number of directors. The research studies prove that there is an inverse association between board size and firm value. Jensen (1993) asserts that a smaller board is easier to monitor as it has fewer incentives for managerial discretion and hence enable the directors to make effective economic decisions.

From an agency perspective, the existence of independent directors on

the board of the company acts as an effective monitoring mechanism to ensure the firm is maximizing shareholder wealth and limiting opportunistic behaviour by management (Fama & Jensen, 1983). Dehaene, De Vuyst and Ooghe (2001) investigated the relationship between board structures and corporate performance of Belgian companies and found that a high proportion of independent directors was associated with better firm performance. A similar result found by Millstein and MacAvoy (1998) shows that US publicly traded corporations with higher number of independent directors tend to perform much better than those with executive directors. In contrast, stewardship theory suggests that inside directors or executive directors are more trustworthy in managing firm resources and their in-depth knowledge about company internal operations is important to enhance firm performance (Donaldson & Davis, 1991). Consistent with the stewardship theory, Agrawal and Knoeber (1996) who studied the relationship between firm performance and mechanisms in controlling agency problem, emphasize that there is a significant negative association between independent directors and company performance based on -6-

Tobin’s Q. In addition, using a 10 year sample period in between 1985 and 1995, Bhagat and Black (1999, 2002) found consistent results showing that U.S. firms with higher number on independent directors do not perform better than other firms based on Tobin’s Q measure. An agency theory suggests that the roles of Chairman and CEO should be held by different people as an individual who holds both positions is more likely to make business decisions based on personal interest, thereby causing financial performance to drop (Jensen, 1986). Ibrahim and Abdul Samad (2011) emphasize that the separation of the roles of Chairman and CEO allows the board to monitor performance of the firm’s top management. Research on the Australian firm’s initial public offerings (IPOs) issued in between 1976 and 1993 shows a positive association between the separation of the Chairperson and CEO roles and financial performance (Balatbat, Taylor and Walter, 2004). In addition, based on a longitudinal analysis on the relationship between duality and organizational performance, Rechner and Dalton (1991) also find that firms with separated roles of Chairman and CEO always outperform firms where both positions are held by a single person. On the other hand, Stewart (1991) promotes CEO duality as it improves business decision making by allowing the CEO to focus on achieving the company objectives and stimulating the rapid implementation of business strategy. It is also argued that clear-cut leadership resulting from CEO duality helps the CEO decide on the firm’s strategic vision with less board interference which could lead to increased financial performance (Dahya, Lonie & Power, 1996; Christensen, Kent & Stewart, 2010). According to Chang and Abu Mansor (2005) who studied the impacts of good corporate governance practices on the performance of 120 listed companies in Malaysia during the 1997 Asian financial crisis, a higher financial performance is usually associated with firm where both positions are held by different people. In addition, based on a contingency model that integrates both agency and stewardship perspectives, Boyd (1995) finds that CEO duality is highly significant and positively associated with the financial performance of U.S. firms. Agency theory argues that a high frequency of board meetings indicates active monitoring on firm’s operational performance by the board (Conger, Finegolda & -7-

Lawler, 1998). Frequent board meetings allows more opportunities for monitoring performance of the top level management, which reduces agency costs and hence enhances firm performance. Lipton and Lorsch (1992) assert that a board of directors who meet frequently are more likely to perform their duties diligently, thereby maximizing shareholder wealth. Vafeas (1999) finds that frequency of board meetings is an important dimension of board operations that can improve board effectiveness. Yatim, Kent and Clarkson (2006) investigated the relationship between audit fees and corporate governance of Malaysian listed firms, and find that frequent board meetings reduce external audit fees by enhancing the effectiveness of the board in overseeing financial reporting process. In Australia, Christensen et al. (2010) show that the frequency of board meetings is inversely related to Tobin’s Q as the market tends to perceive a high number of board meetings as an indication of board inefficiency in discharging responsibilities or poor firm performance that requires more attention from the board. The existence of an audit committee increases the integrity of firm’s financial disclosures through monitoring financial reporting and audit processes (Christensen et al., 2010). The audit committee provides the greatest level of protection to shareholders as they ensure that the firm complies with mandatory disclosure requirements in providing high quality financial information. Further, an audit committee serves as a corporate mechanism on the board that helps to reduce earnings management practices (Abdul Rahman & Mohamed Ali, 2006; Mohd Saleh, Mohd Iskandar & Mohid Rahmat, 2007). Hamdan, Sarea and Reyad (2013) emphasize that there is a positive relationship between audit committee characteristics such as audit committee size, financial experience and audit committee independence, and financial performance of Jordanian firm listed in the Amman Stock Exchange Market. In addition, a similar research conducted by Aldamen, Duncan, Kelly, McNamara and Nagel (2012) shows that firms with an audit committee that has more experience and financial expertise are more likely to achieve better financial performance compared to other firms. The nomination committee is an effective monitoring mechanism that is highly recommended in corporate governance codes. The existence of a nomination committee is highly associated with improved financial performance as it is able to provide unbiased assessment on the quality of the appointed directors (Christensen et al., 2010). Brick and Chidambaran (2010) who examined the impacts of board monitoring -8-

committees on the value of U.S. firms over the period from 1999 to 2005, find that firms that chose not to adopt fully independent board committee includes nominating committee were the firms with poor performance as measured by Tobin’s Q. The main role of the remuneration committee is to develop and review remuneration policies on behalf of the board, including the nature and amount of compensation paid to directors. Previous literature shows positive results on the relationship between the existence of a remuneration committee and firm performance. Several studies using data from U.S. firms indicate a significant positive relationship between the existence of a remuneration committee and financial performance (Jensen & Murphy, 1990; Core, Holthausen & Larcker, 1999). The positive findings show the effectiveness of nomination committee in aligning the interests of management and shareholders through the implementation of incentive schemes, and hence mitigate agency costs. Similarly, Yatim (2012) who examined the relationship among firm performance, corporate governance structures and director’s remuneration of listed firms in Bursa Malaysia, finds strong support for the positive linkage between firm performance and the existence of a remuneration committee. Besides, in the Australian stock market, firms with remuneration committee are more likely to earn higher shareholders returns compared with firms that do not have remuneration committee (Calleja, 1999).

3.0

Methodology

3.1

Variables Selection In order to determine the relationship between corporate governance and

financial performance, this study analyse a model comprising of financial performance indicator (as the dependent variable) and selected corporate governance indicators (as the independent variables). The Tobin’s Q ratio is adopted as a proxy to evaluate the financial performance of the Malaysian listed construction companies. Tobin’s Q is defined as the ratio between the market value of the firm’s assets and the replacement value of those assets (Chung & Pruitt, 1994). The ratio provides a comparison on the total outstanding equity and debt in market value to the total assets at book value. This -9-

research adopts the formula used by Haniffa and Hudaib (2006) in calculating Tobin’s Q ratio as follows; Tobin’s Q = Where: CS

Common shares at market value

TD Total debt TA Total assets at book value

Tobin’s Q is defined in this research as the ratio of the market value of common shares plus total debt divided by the book value of total assets of the company (Tobin, 1969; Chung & Pruitt, 1994; Haniffa & Hudaib, 2006). An increase in the value of Tobin’s Q shows that the financial market is placing higher value on the company. A Tobin’s Q ratio more than 1 indicates that the company has higher market value than the book value of its assets. This means that the company is able to create more value by using available resources effectively (Li, Oum & Zhang, 2004), has better investment opportunities (Lang, Stulz & Walkling, 1989), and has a higher growth potential (Brainard & Tobin, 1968; Tobin, 1969). Conversely, a Tobin’s Q ratio less than 1 indicates that the company’s market value is less than the book value of the assets. This shows that the company has poor utilization of available resources and hence reduce incentives to invest because the value of new capital investment falls below its costs (Li, Oum & Zhang, 2004). As for the independent variables, selection is made based on the existing literature in this area. Thus, the analysis includes corporate governance structures, namely (i) board size; (ii) board independence; (iii) role of duality; (iv) number of board meetings; (v) existence of audit committee; (vi) existence of nomination committee; and (vii) existence of remuneration committee as the independent variables. These variables are self-explanatory and clearly stated in the annual reports with the exception of board independence. When the company does not disclose whether the non-executive directors are fully independent in accordance to the Bursa Malaysia Listing -10-

Requirements, this research assumes that the non-executive directors are not independent. Additionally, two control variables included in this study, which are firm size and level of debt. The size of the company is measured by the log of total book value of assets at balance date and the level of debt is calculated by dividing the company’s total liabilities by total assets. The debt level is measured by the ratio of total liabilities to total assets. These two control variables are included in the regression analysis as firm size and debt level are determined to have high impacts on the financial performance of the company. Hence, controlling these two research variables provides more powerful explanation on the association between the corporate governance structures and the financial performance. There are numerous empirical studies that support the significant association between firm size and financial performance (Mohd Ghazali, 2010; Haniffa and Hudaib, 2006). Chang (2004) finds that larger firms are highly associated with better financial performance which may be due to the greater amount of capital owned by larger firms and their ability to diversify risks in more efficient way. In contrast, the research findings of Christensen et al. (2006) show a negative relationship between firm size and financial performance. This may suggest that smaller firms are more creative, innovative and flexible in enhancing corporate value (Hannan & Freeman, 1989). Jensen (1986) and Stulz (1990) suggest debt financing is an effective mechanism to improve firm performance by controlling the manager’s discretion over free cash flow and encouraging them to engage in more productive investment. Besides, managers with debt contracting show improved firm performance and become more efficient in avoiding bankruptcy (John & Senbet, 1998). These theoretical ideas are aligned with the result found by Haniffa and Hudaib (2006) and Christensen et al. (2010), suggesting that the market tends to place higher valuations on firms that operate at higher level of debts. This may also indicate that higher debt financing promises an increase in future firm growth and performance.

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3.2

Operationalization of Research Variables Table 1 below provides a summary of the operationalization of the research

variables, which illustrates how the dependent, independent and control variables are measured in this research, and the expected sign for each variable.

Table 1. Summary of the Operationalization of the Research Variables Variables

Acronym

Expected Sign

Measurement

Dependent Variable: Tobin’s Q

Ratio of the market value of common shares plus total debt divided by the book value of total assets of the company

Independent variables: Board size the

BSZIE

-

Board independence

BIND

+/-

The proportion (%) of independent directors to total number of directors on the board of the company

Role of duality

DUAL

+/-

Dummy variable for dual role of CEO/Chairman, 1 if the CEO is also the Chairman, and 0 otherwise

Board meetings

BMEET

+

Number of board meetings each year

Audit Committee

AUDIT

+

Dummy variable for audit committee existence, 1 if the company has an audit committee, and 0 otherwise

Nomination Committee

NOMN

+

Dummy variable for nomination committee existence, 1 if the company has a nomination committee, and 0 otherwise

Remuneration Committee

REMUN

+

Dummy variable for remuneration committee existence, 1 if the company has a remuneration committee, and 0 otherwise

Control variables Firm size

SIZE

+/-

Log of total book value of assets at balance date

Debt level

DEBT

+

Ratio of total liabilities to total assets

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Total number of directors on the board of company

3.3

Data The data consists of all construction companies listed on Bursa Malaysia in the

year 2009 and 2012. There are a total of 38 construction companies, which were listed on the main board of Bursa Malaysia from 2009 to 2012. This research uses secondary data that are extracted from the 2009 and 2012 annual reports that have been published by the companies. The annual reports are downloaded from the Bursa Malaysia website. All information regarding the board of the companies such as number of directors, proportion of independent directors, frequency of board meetings, and existence of board committees are extracted from the company’s statement of compliance with corporate governance. Whereas, financial information about the company’s total assets, total liabilities and amounts of share capital are extracted from the financial statement and the report to shareholders sections in the annual report.

3.4

Multiple Linear Regression Model After determining the research variables, a multiple regression model is

developed to test the statistical association between the corporate governance structures and the financial performance. This research runs two set of multiple regression analyses for both 2009 and 2012 financial data. The multiple regression analyses have been conducted based on the following equations;

= β0 - β1 BSIZE +/- β2 BIND +/- β3 DUAL + β4 BMEET + β5 AUDIT + β6 NOMN + β7 REMUN +/- β8 FSIZE + β9 DEBT + ε = β0 - β1 BSIZE +/- β2 BIND +/- β3 DUAL + β4 BMEET + β5 AUDIT + β6 NOMN + β7 REMUN +/- β8 FSIZE + β9 DEBT + ε Where; Tobin’s Q

Company’s Tobin’s Q ratios.

BSIZE

Board size.

BIND

Board independence. -13-

DUAL

Role of duality.

BMEET

Board meetings

AUDIT

Existence of audit committee

NOMN

Existence of remuneration committee

REMUN

Existence of remuneration committee

FSIZE

Firm size

DEBT

Level of debt

ε

term of error

4.0

Results and Discussion

4.1

Descriptive Statistics Table 2 presents the descriptive statistics for the variables, with Panel A

reporting those for the continuous variables and Panel B for the dichotomous variables. The mean of Tobin’s Q ratio decreased from 1.2 in 2009 to 0.886 in 2012. This does not necessarily show that the market placed lesser value on the listed construction companies in 2012. However, the higher mean in 2009 is due to extremely high Tobin’s Q ratio of 13.482 recorded for Ark Resources Berhad, which had an extensively low amount of total assets compared to its total liabilities. The average Tobin’s Q ratio of 0.886 in 2012, which is less than 1, indicates that the listed construction companies in Malaysia had its stock undervalued. The result is lower compared to the average Tobin’s Q ratio of 1.13 found by Haniffa and Hudaib (2006) based on a sample of 347 Malaysian listed companies from 1996 to 2000. The average board size of Malaysian listed construction companies is between 7 to 8 directors, which is within the size recommended by Lipton and Lorsch (1992) for achieving high level of board effectiveness. Similar average number of directors is also found by Haniffa and Hudaib (2006), Mohd Ghazali (2010), and Ibrahim and Abdul Samad (2011). This finding supports the view that Malaysian listed companies have a preference maintaining a medium number of directors on the board. The code states that the board should examine its own size, with a view to determining the impact of the number upon its effectiveness. -14-

The descriptive statistic shows that Malaysian listed construction companies had 42.7% and 47.6% of independent directors on the board in 2009 and 2012 respectively. The increase of the average proportion of independent directors on the board shows growing awareness on the importance of board independence in enhancing financial performance by Malaysian listed construction companies. We also found that Malaysian listed construction companies held the board meetings on average 5 to 6 times per year in 2009 and 2012, as suggested by the Institute of International Finance (IIF) in its Code of Corporate Governance 2003, that board meetings should take place at least four times a year (IIF, 2006). Similar average board meetings also found by Mohd Noor and Fadzil (2013), and Taghizadeh and Saremi (2013) who used bigger sample of listed companies in Malaysia. The number of the Chairman who also held the CEO position at Malaysian listed construction companies in 2009 and 2012 are 8 (21.05%) and 9 (23.68%) respectively. This indicates that appointing a same person for both Chairman and CEO positions is not common in Malaysian listed construction companies. The result shows that all Malaysian listed construction companies had established audit committee, nomination committee and remuneration committee.

Table 2. Descriptive Statistics of Variables 2009 data Panel A: Continuous variables

n = 38

Variable:

Minimum

Maximum

Mean

Tobin’s Q BSIZE BIND BMEET FSIZE DEBT

0.450 5 0.286 4 17.169 0.115

13.482 13 0.667 10 24.539 10.066

1.2 8 0.427 5.395 20.111 0.727

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Median 0.837 8 0.408 5 19.989 0.435

Standard deviation 2.065 1.931 0.1 1.405 1.394 1.568

2012 data Panel A: Continuous variables

n = 38

Variable:

Minimum

Maximum

Mean

Median

Tobin’s Q BSIZE BIND BMEET FSIZE DEBT

0.396 4 0.286 4 17.140 0.027

1.973 13 0.8 11 24.667 0.854

0.886 7.368 0.476 5.605 20.226 0.486

0.846 7 0.429 5 20.053 0.470

Standard deviation 2.06 1.93 0.11 1.405 1.394 1.568

2009 data Panel B: Dichotomous variables Variable:

Yes

Percentage (%)

DUAL AUDIT NOMN REMUN

8 38 38 38

21.05 100 100 100

Variable:

Yes

Percentage (%)

DUAL AUDIT NOMN REMUN

9 38 38 38

23.68 100 100 100

2012 data Panel B: Dichotomous variables

4.2

Analysis Before running the multiple regression analysis, three independent variables,

AUDIT, NOMN and REMUN were dropped from the model because both the 2009 and 2012 data shows that all listed construction companies in Malaysia had an audit committee, a nomination and a remuneration committee. The following variables are constant and by including these variables in the model, it would not help to improve the ability of the model to better explain the association between the corporate governance structures and firm financial performance. After dropping out these variables, the multiple regression models become; -16-

= β0 - β1 BSIZE +/- β2 BIND +/- β3 DUAL + β4 BMEET +/- β8 FSIZE + β9 DEBT + ε = β0 - β1 BSIZE +/- β2 BIND +/- β3 DUAL + β4 BMEET +/- β8 FSIZE + β9 DEBT + ε

The multiple regression analysis was used to find the association between the corporate governance structures and the financial performance of the Malaysian listed construction companies in 2009 and 2012. Table 3 reports the result of the multiple regression analysis for the 2009 data and Table 4 for the 2012 data. The 2009 data produces a high adjusted R2 of 0.985, which indicates the corporate governance variables are able to explain 98.5% of the variation in the Tobin’s Q ratio. However, low adjusted R2 of 0.226 for the 2012 data indicates that the regression model has lesser explanatory power in explaining the total variation between the corporate governance variables and firm financial performance in 2012. The F-statistic shows that the 2009 and 2012 regression model have significance level of 0.00 and 0.014 respectively, which is less than 0.05, and therefore there is a statistically significant difference in firm performance, measured by the Tobin’s Q ratio that can be explained by variation in the corporate governance variables

.

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Table 3. Regression result of 2009 data with n = 38 2009 R2 Adjusted R2 Standard Error F-statistic F-significance Number of observations Variables: Constant BSIZE BIND DUAL BMEET FSIZE DEBT

0.987 0.985 0.256 394.881 0.000 38 Coefficient

Standard error

4.139 0.133 0.662 0.035 0.022 -0.265 1.276

0.709 0.037 0.472 0.119 0.031 0.045 0.029

t- statistic

Significance

5.835 3.577 1.401 0.297 0.711 -5.924 43.382

0.000 0.001 0.171 0.769 0.483 0.000 0.000

t- statistic

Significance

3.601 0.468 1.212 0.098 0.619 -3.100 2.328

0.001 0.643 0.235 0.923 0.540 0.004 0.027

Table 4. Regression result of 2012 data with n = 38 2012 R2 Adjusted R2 Standard Error F-statistic F-significance Number of observations

0.385 0.266 0.287 3.236 0.014 38

Variables:

Coefficient

Constant BSIZE BIND DUAL BMEET FSIZE DEBT

2.789 0.017 0.480 0.012 0.020 -0.132 0.629

Standard error 0.774 0.036 0.396 0.122 0.033 0.043 0.270

Board size (BSIZE) is found to have a significant relationship (p < 0.05) with the Tobin’s Q ratio in 2009, but not significant (p > 0.05) in 2012. The result shows that board size is positively related to the Tobin’s Q ratio, which contradicts the findings of Yermack (1996), Mak and Kusnadi (2005), Haniffa and Hudaib (2006), and Ibrahim and Abdul Samad (2011), all of whom suggest that reducing board size can improve firm performance. However, the positive result may indicate that Malaysian listed construction firm with bigger board size is able to generate higher market value due to -18-

high diversity and broad range of expertise provided by the directors that would help the firm to utilize the critical resources more efficiently in construction projects. The positive relationship found is consistent with the study of Pfeffer (1987), Pearce and Zahra (1992), and Goodstein, Gautum and Boeker (1994). The results show that none of board independence (BIND), role of duality (DUAL), and number of board meetings (BMEET) are significantly related (p > 0.05) to Tobin’ Q ratio in 2009 and 2012. The result shows that board independence (BIND) are positively related to the Tobin’s Q in 2009 and 2012. This is consistent with the findings of Millstein and MacAvoy (1998), and Dehaene et al. (2001), suggesting that Malaysian listed construction companies with higher proportion of independent directors may have better financial performance. A positive relationship is also found between CEO duality (DUAL) and Tobin’s Q ratio in 2009 and 2012. This result supports the findings of Boyd (1995), Chang and Abu Mansor (2005), and Christensen et al. (2010). This indicates that the presence of CEO with dual role as Chairperson improves the financial performance of listed construction companies in Malaysia. Frequency of board meetings (BMEET) is positively related to the financial performance in 2009 and 2012, as measured by Tobin’s Q ratio. The result aligns with agency theory used in the study of Conger et al. (1998) that frequent board meetings indicate active monitoring on firm’s operational performance by the board. The result also supports the view of Lipton and Lorsch (1992), Vafeas (1999), and Yatim et al. (2006). The positive relationship may suggests that the board has to meet more frequently due to complexity of construction industry in Malaysia, scarcity of resources and high number of construction projects in order to improve board effectiveness and firm performance. The existence of audit committee (AUDIT), the existence of nomination committee (NOMN) and the existence of remuneration committee (REMUN) variables were withdrawn from the regression analysis as they have been determined to have constant effect. The control variables, firm size (FSIZE) and debt level (DEBT) are found significantly related (p < 0.05) to Tobin’s Q ratio in 2009 and 2012. The result shows that there is a negative significant relationship between firm size (FSIZE) and Tobin’s Q ratio. The negative relationship supports the findings of Hannan and Freeman (1989), -19-

Weir and Laing (1999), Haniffa and Hudaib (2006), Christensen et al. (2006), Mohd Ghazali (2010), and San and Heng (2011), suggesting that smaller firms are highly associated with better financial performance. The result indicates that small listed construction companies in Malaysia are more efficient and innovative in utilizing their capital to generate higher corporate value. The result shows that debt level (DEBT) has a significant positive relationship with Tobin’s Q ratio. The positive result is consistent with the findings of John and Sebet (1998), Haniffa and Hudaib (2006) and Christensen et al. (2010), suggesting that the market places higher valuations on companies that use more leverage. The result signals that Malaysian listed construction companies that operate at high level of debt are able to acquire more advanced construction technology, and hence improve corporate performance.

5.0

Conclusion This research examines the relationship between seven corporate governance

structures, namely (i) board size; (ii) board independence; (iii) role of duality; (iv) number of board meetings; (v) existence of audit committee; (vi) existence of nomination committee; and (vii) existence of remuneration committee, and the financial performance of Malaysia listed construction companies, measured by Tobin’s Q ratio in 2009 and 2012. Contrary to prior research, we found that board size is positively associated with financial performance in 2009 and 2012, suggesting that larger board are perceived to have a diversified and broad range of expertise and knowledge related to construction industry that is valuable for firms to enhance their financial performance. The result shows that board independence, role of duality and number of board meetings are not significantly related to Tobin’s Q ratio in 2009 and 2012. We found that higher proportion of independent directors on the board is positively associated with financial performance. This aligns with the agency theory proposed by Fama and Jensen (1983) that the roles of independent director are important in monitoring the board to prevent manipulation of resources and hence maximize shareholder’s wealth. -20-

CEO duality is found to have a positive relationship with firm performance in 2009 and 2012, suggesting that the market perceive a firm with both Chairman and CEO position held by same person makes better economic decisions. There is a positive relationship found between number of board meetings and financial performance of Malaysian listed construction firms in 2009 and 2012. This supports an agency theory saying that high frequent board meetings allows for monitoring performance of the top level management and hence reduce agency costs (Conger, Finegolda & Lawler, 1998). Future studies may want to include more thorough and meaningful corporate governance variables to establish a stronger link between corporate governance structures and firm performance. Other aspects of corporate governance variables that future studies may want to consider are independence of the nomination committee and transparency of remuneration policies, tenure of independent directors, financial literacy and accountancy qualification of the audit committee members, and participation of shareholders at general board meetings. Future research could also explore internal governance structures of listed firms in Malaysia, such as nominating procedures and risks management system to develop a comprehensive research framework to examine the relationship between board effectiveness and financial performance, combining in-depth qualitative methods with quantitative methods. A semi-structured interview with those involved in determining governance policies and overseeing board structures within the company may enhance the understanding on adoption and implementation of the corporate governance code.

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