The Impact of Ownership Structure on Supervisory Board Size and ...

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ScienceDirect Procedia Economics and Finance 23 (2015) 1420 – 1425

2nd GLOBAL CONFERENCE on BUSINESS, ECONOMICS, MANAGEMENT and TOURISM, 30-31 October 2014, Prague, Czech Republic

The Impact of Ownership Structure on Supervisory Board Size and Diversity: Evidence from the Polish Two-tier Board Model Leszek Bohdanowicza* a

University of Lodz, Faculty of Management, Matejki Street 22/26, 90-237 Lodz, Poland

Abstract Most studies of boards of directors are conducted using the Anglo-Saxon corporate governance system, and additionally using the one-tier board model. Little still is known about the structure of these bodies in countries where ownership is concentrated and additionally the board model is a two-tier one. This article tries to fill this gap, and its purpose is to describe the impact of the different types of ownership on the size and diversity of supervisory boards in the Polish two-tier board model. In this study, panel data analysis is applied in order to examine whether there are differences in supervisory board size and gender diversity on supervisory boards with foreign, managerial, state and financial investor ownership. Amongst others, the results reveal that state ownership positively influences supervisory board diversity and managerial ownership is positively associated with supervisory board diversity. Moreover, financial investor ownership positively affects supervisory board size. The paper also explains how these relationships influence on the supervisory boards of Polish listed companies. © 2015 2014 The TheAuthors. Authors.Published PublishedbybyElsevier ElsevierB.V. B.V. © This is an open access article under the CC BY-NC-ND license Selection and/ peer-review under responsibility of Academic World Research and Education Center. (http://creativecommons.org/licenses/by-nc-nd/4.0/). Selection and/ peer-review under responsibility of Academic World Research and Education Center Keywords: Corporate governance, two-tier board model, board structure, Poland;

1. Introduction In the wake of corporate fraud and the recent financial crisis, boards of directors have become a popular topic of research. Most of this research examined the relationship between board structure and company performance (Dalton and Dalton, 2005) or evaluated board tasks (Machold and Farquhar, 2013). Their results were often ambiguous, which show that there is a need for further studies on corporate boards in different systems of corporate governance. However, this research has been conducted in Poland and its purpose is to describe the impact of the

* Leszek Bohdanowicz. Tel.: +48 42 635 50 59; fax: +48 42 635 53 05. E-mail address: [email protected]

2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Selection and/ peer-review under responsibility of Academic World Research and Education Center doi:10.1016/S2212-5671(15)00429-3

Leszek Bohdanowicz / Procedia Economics and Finance 23 (2015) 1420 – 1425

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different types of ownership on the size and diversity of supervisory boards in the Polish two-tier board model. The current understanding of the determinants of board structure is full of gaps. Firstly, most studies of boards of directors have been conducted using the Anglo-Saxon systems of corporate governance, and therefore in a one-tier board model. Little still is known about the structure of these bodies in countries, where ownership is concentrated and in addition where the board model is a two-tier one. Secondly, many studies noted that the type of owner affects company performance (Alfaraih et al., 2012). Still not enough is known about the influence of shareholders on the structure and functioning of corporate boards. Such studies are in themselves useful as a means of explaining the relationship between corporate boards and company performance. However, this study attempts to fill these gaps. 2. Literature Review 2.1. Polish system of corporate governance Weimer and Pape (1999) constructed a taxonomy of systems of corporate governance and have identified four of these, i.e. Anglo-Saxon, Germanic, Latin and Japanese. According to this taxonomy the Polish system of corporate governance can be classified as a Germanic. However, it is characterized by a highly concentrated ownership in listed companies and an inactive market of external control (Tamowicz and Dzierżanowski, 2001). The most important and also the most influential owners of Polish companies are strategic (foreign) investors, the government and institutional (financial) investors. Medium-sized and small companies are often still managed by their founders who are often CEOs of these companies. Moreover, the relevance of the Warsaw Stock Exchange as an external market for corporate control is rather limited, and majority shareholders often exercise direct supervision of the companies (Tamowicz, 2011). As a result capital markets are not as demanding and companies are not as willing to implement the best practices in corporate governance i.e. Best Practices of WSE Listed Companies including rules relating to board structure (Campbell et al., 2009). The Polish board model is a two-tier one with a management board and a supervisory board. The supervisory board consists solely of external directors while the management board is composed of internal directors. In accordance with company law, the management board is responsible for managing the company. It is the real decision-making body, which is responsible for the formulation of a strategy and for operations. The supervisory board exercises day-to-day supervision in all areas of the company’s activity. Its duties also include the granting of contracts to members of the management board, strategic and financial decisions, reviewing the firm’s performance with the management board, approving annual reports, and selecting auditors. Generally, Polish supervisory boards are monitoring bodies and they are perceived as passive and reactive (Jeżak, 2010). 2.2. Supervisory board size and diversity Literature on the subject has emphasized that both too numerous corporate boards and too small corporate boards have their weaknesses. Too large boards suffer from increased problems of communication and coordination, too small from decreased ability to fulfil their function (Eisenberg, 1998). However, according to some research conducted on the one-tier board model too large corporate boards can make more awkward the processes of coordination, communication, and decision making (Lipton and Lorsch, 1992; Jensen, 1993; Eisenberg, 1998). But since the supervisory boards in the two-tier board model are the approval and monitoring bodies, much more important for them it is to generate various opinions and points of view. Their decisions are made later by a vote, which reduces problems in communication. Even more frequently in the literature mentions the issue of board diversity, including its advantages and disadvantages. Groups of people, including corporate boards can be diverse in terms of age, gender and many other personal characteristics. Recently, many studies were carried out on the diversity of boards in terms of gender. The starting point for these was that the corporate boards are homogenous and dominated by male directors (Brammer et al., 2007). What's more, such boards do not use the benefits of diversity and become “old boys clubs”. However, there are some solid arguments for appointing more women and an increase of gender diversity in the boardroom (Burgess and Tharenou, 2002). These include amongst others: the companies access to the full range of available social and intellectual capital, improvement of corporate reputation, contribution to board decision making and its

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strategic involvement, and the distinct leadership style of female directors. However, it has been emphasized within literature on the subject that diverse groups of people behave differently than homogeneous groups. Generally, the diversity affects their dynamics and the process of their decision-making. Members of homogeneous groups often communicate with each other and often reach agreement. Such groups are more focused on cooperation and less prone to conflict and are less time consuming when making decisions (Earley and Mosakowski, 2000). On the other hand, homogeneous groups are often affected by groupthink (Watson et al., 1993). Moreover, diverse groups of people make decisions longer, but are able to generate a larger number of solutions and ideas. This is extremely beneficial in the case of supervisory boards. The size and diversity of corporate boards can be determined by many factors, including firm size, firm age, number of business segments, free cash flows, industry, takeover defense, firm performance, R&D strategy and ownership structure (Hillier and McColgan, 2006; Boone et al., 2007). In companies and systems of corporate governance, which have concentrated ownership, majority shareholders mostly decide on the composition and size of boards. This also applies to the Polish system of corporate governance and Polish companies. They can be also influenced by the type of shareholders (Mak and Li, 2001). Since this is so, in this study I try to answer two questions. First, what types of investors gain the benefits of the size and diversity of supervisory boards? Second, how can we explain the relationships between the different types of ownership and the size and diversity of supervisory boards? In view of this, hypothesis can be presented as follows: ownership structure (managerial ownership, foreign investors ownership, financial investors ownership, state ownership) affects supervisory board size and supervisory board diversity. 3. Research results 3.1. Sample and variables The sample frame for this study consists of 382 Polish companies listed on the Warsaw Stock Exchange between 2004 and 2012. This gives an unbalanced initial panel sample of 2,377 firm-year observations. Data were handcollected and obtained from annual reports. The sample contains only non-financial companies. Financial institutions are excluded due to their unique financial structure and special accounting rules for the financial sector. Since the data covers a nine year period, it has been analyzed using panel data analysis (a fixed-effects model). To test the hypothesis I use two dependent variables i.e. supervisory board diversity and supervisory board size. As a proxy for supervisory board diversity, I use the percentage of women on the supervisory board (Campbell and Minguez-Vera, 2008). This variable is calculated as a decimal number. The second dependent variable is supervisory board size. It is measured as the total number of directors on supervisory boards. Moreover, I use four various independent variables i.e. managerial ownership (ownership by management board members), foreign ownership, state ownership and financial (institutional) investor ownership. Similar variables describing ownership structures are used most often in concentrated systems, both in studies conducted within European and Asian countries (Saleh et al., 2009; Bohdanowicz and Urbanek, 2012), and sometimes also in countries, where dispersed ownership exists (Florackis and Ozkan, 2009). Ownership variables are all calculated as direct and indirect voting rights at the general meeting. Moreover, because of the availability of data I take into account only blocks of shares in excess of the 5% threshold. After exceeding this threshold, shareholders are required to make them available to the public. One, I use managerial ownership. For the calculation of this variable I also take into account the shares owned by family members of those managers. I believe that this relationship strengthens their position in the company and the opportunity to influence supervisory board structure and size. Two, I use foreign ownership. Among the foreign investors are foreign companies and individuals. Three, I use state ownership. In the case of this variable, indirect ownership through institutional (financial) investors is not accounted for, but indirect ownership through government-controlled companies is. Four, I use institutional (financial) investors ownership. This group included Polish and foreign banks, insurance companies, brokerages, open-end pension funds, open-end and closed-end investment funds, venture capital and private equity funds. The control variables are: management board size, management board diversity, company performance, company size and industry. I employ total assets at the end of the fiscal year as a proxy for the scale of the firm to control influence of company size on board size and board diversity. This is transformed with a natural logarithm (Brick and

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Chidambaran, 2010). Since the Polish board model is two-tier, I use analogous to the size and diversity of the supervisory board, the size and diversity of the management board as control variables. The next control variable is used to measure industry. This variable is a dummy variable, which is equal to 1 for industrial companies and 0 otherwise (Alfaraih et al., 2012). Moreover, this is included in the Return on Assets (ROA) as a measure of company performance. 3.2. Descriptive statistics Table 1 depicts descriptive statistics. Supervisory board size across my entire sample is 5.6895 and management board size is 3.0770. Furthermore, the mean of supervisory board diversity is 0.1395 with a standard deviation of 0.1696. The management boards of companies were even less diverse. The mean of gender diversity on the management board is 0.1035 with a standard deviation of 0.2016. These results indicate that Polish supervisory and management boards are homogenous and male-dominated. In the variables describing the shares of various shareholder groups, the largest mean was recorded for members of the management board (at 0.1877), next for foreign investors ownership, with an average of 0.0839 and institutional investors ownership with an average of 0.06. The lowest average value was recorded for the state ownership variable (0.0270). This shows that state ownership considerably decreased in value and that privatization meant that ownership in Poland’s economy similar to that in developed economies. The mean natural logarithm of total assets (company size) is 19.1485 and the mean of return of assets (company performance) is 0.0122. Table 1. Descriptive statistics. Variable

Mean

Standard deviation

10th percentile

90th percentile

Supervisory board size

5.6895

1.2911

5.0

7.0

Supervisory board diversity

0.1395

0.1696

0.0

0.4

Managerial ownership

0.1877

0.26891

0.0

0.6598

State ownership

0.0270

0.11475

0.0

0.0

Financial investors ownership

0.06

0.1595

0.0

0.3267

Foreign ownership

0.0839

0.2089

0.0

0.4979

Management board size

3.0770

1.4758

2.0

5.0

Management board diversity

0.1035

0.2016

0.0

0.4

Company size

19.1485

1.6228

17.1847

21.2399

Company performance

0.01221

0.2292

-0.0978

0.1294

3.3. Multivariate analysis Table 2 illustrates the results of the panel data estimation for my sample. The first findings are that there are significant and positive relationships between state ownership and supervisory board size (β = 0.7077, p < 0.05) and supervisory board diversity (β = 0.0583, p < 0.05). Moreover, managerial ownership positively relates to supervisory board diversity, but negatively to supervisory board size (β = -0.2353, p < 0.05). Financial investors ownership is positively associated with supervisory board size (β = 0.3181, p < 0.1), but negatively with supervisory board diversity (β = -0.1211, p < 0.001). Furthermore, my analyses identifies several relationships between some of the dependent and control variables including a positive relationship between management board size and supervisory board size (β = 0.0847, p < 0.001) and a negative relationship between company performance and supervisory board size (β = -0.1679, p < 0.05). Moreover, company size is negatively associated with supervisory board size (β = -0.0093, p < 0.05).

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Leszek Bohdanowicz / Procedia Economics and Finance 23 (2015) 1420 – 1425 Table 2. Panel data estimation Independent and control variables Managerial ownership State ownership Financial investors ownership Foreign ownership Management board diversity Supervisory board diversity Supervisory board size Management board size

Dependent variables Supervisory board size -0.2353* (0.1144) 0.7077* (0.3012) 0.3181† (0.1664) 0.0457 (0.1981) _ -0.2278 (0.1522) _

Supervisory board diversity 0.0583*** (0.0168) 0.1032* (0.0445) -0.1211*** (0.0244) -0.0337 (0.0292) -0.0155 (0.0153) _ -0.0049 (0.0033) _

0.0847*** (0.0186) Company performance -0.1679* -0.0062 (0.0692) (0.0102) Company size 0.0191 -0.0093* (0.0323) (0.0047) Industry No No Constant 5.2801*** 0.3298** (0.6943) (0.1036) N 2,377 2,377 Adjusted R-square 0.8084 0.7580 F-statistic 20.971*** 15.570*** Note: † p < 0.1; * p < 0.05; ** p < 0.01; ***p < 0.001. Standard error is given in brackets.

4. Summary This study is devoted to identifying the impact of ownership structures in Polish listed companies on the size and diversity of corporate boards. Since the Polish board model is a two-tier one, my research is focused on supervisory boards. The results of this study support some relationships that can shed some light on the functioning of the supervisory board. Firstly, there are negative relationships between managerial ownership and supervisory board size and positive between managerial ownership and supervisory board diversity. Generally, supervisory boards in companies with significant managerial ownership are seen as passive and owner-managers limit their role (Greco, 2010). This explains the first relationship. At the same time owner-managers appoint to the supervisory boards members of their families, including women. Thus they increase gender diversity in the boardroom, but without the utilization of the advantages of gender diversity. Secondly, there are positive relationships between state ownership and board diversity and supervisory board size. The results are consistent with findings that politicians react with a rapid response to external pressure and care for women’s participation in various spheres of life including business (Terjesen and Singh, 2008). Potentially, companies with state ownership could take advantage of gender diversity in the boardroom, but there is also some evidence that state ownership negatively affects firm performance, and SOEs perform substantially less efficiently than private companies, also because some board members are appointed mainly due to their political connections and their competencies are not of essence (Boardman and Vining, 1991). For this reason supervisory boards of state owned companies can be also numerous. Thirdly, there are positive relationships between financial investor ownership and supervisory board size and negative between financial investors ownership and supervisory board diversity. The first relationship is associated with the specific of ownership structures of Polish listed companies. Financial investors exercise direct supervision over companies and their representatives are appointed to the supervisory board. At the same time dominant shareholders maintain control over supervisory boards appointing connected board members. These two trends lead


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