How Corporate Governance Practice Is Disclosed In Retail Finance Essay - Free Essay Example

The topic of corporate governance is vital to every corporation, especially the listed corporation, because the related principles guide the business practice and provide higher values with higher profitability for the corporation, (Aksu and Kosedag 2005). Corporate governance is about rules and regulations and also a matter of ethics, therefore failure to comply with it has an unfavorable impact on the capital market and their investors, (International Federation of Accountants 2008). The lack of effective corporate governance in a corporation results in huge amount of financial losses, like the Hong Kong listed company: CITIC Pacific Limiteds incident in 2008. This signals corporations that good corporate governance practice is fundamental to corporations success. This study is to find out the relationship between corporate governance practice and financial performance of corporations. More importantly, the Code of Corporate Governance Practice has become effective from 1 January 2005 onwards and listed corporations in Hong Kong must comply with the mandatory provisions. Corporations are also encouraged to comply with the voluntarily guidelines for best practices. Judges Report of the Hong Kong Management Association Best Annual Report Award 1994 pointed out that prior research shows that corporations only comply with minimum disclosure requirements of corporate governance standards. This study is going to assess the level of compliance of corporations with both mandatory provisions and voluntarily practices. It is commonly agreed that corporations in industry other than retail, especially the banking, public utility service, and property development industry, have better performance in corporate governance since 1990s when the corporate governance standards have evolved significantly. For example, HSBC Holdings plc won the Best Corporate Governance Disclosure Award 2009 from Hong Kong Institutes of Certified Public Accountants (HKICPA); CLP Power Hong Kong Limited won the top award from the HKICPA for the seventh successive year; and Sun Hung Kai Properties Limited obtained the Corporate Governance Asia Recognition Award in 2009 from the Corporate Governance Asia Magazine. But for the retail industry, there is less prior research for investigating the corporate governance disclosure of these companies. Therefore this study is going to investigate the practice in the retail industry. 1.2 Research Aims and Objectives 1.2.1 Research Aims The research aims of this study are to examine how corporate governance practice is disclosed in the retail industry and how it contributes to the corporations by looking at its impact on firms performance in operating, financial and stock market aspects. 1.2.2 Research Objectives The objectives of this study are: To critically examine the importance of corporate governance to corporations and identify the contributions of corporate governance framework. To evaluate the disclosure behavior of listed firms in retail industry of Hong Kong. To compare corporate governance practice of the listed firms in retail industry of Hong Kong. To investigate whether or not companies with good governance would have better performance in operating, financial and stock market aspects by conducting ratio analysis. 1.3 Research Outline The remainder of the research is set as follows. Chapter 2 reviews prior research and literature about theoretical framework, importance and contribution of corporate governance, development of governance disclosure, measurement of corporate governance, and hypotheses development. Chapter 3 describes the methodologies of the research. Chapter 4 shows the empirical findings: (1) corporations ranking for governance disclosure, and (2) relationship between corporate governance and performance. Chapter 5 concludes the research. Chapter 2: Literature Review 2.1 Definition There is no single definition for corporate governance as it varies from countries by countries and firms by firms and depends on how one view this (Craig et al. 2007; Salehi 2008). Salehi (2008) summarized the studies of prior researchers and grouped corporate governance into four views: accountability, integrity, efficiency and transparency. For the purpose of measuring corporate governance, corporate governance is defined as the reciprocal actions and influence of agents (managers and directors) and principal (shareholders) to manage the corporation in which the actions enable stakeholders to obtain certain returns from that corporation (Standard Poors Governance Service 2004). The Hong Kong Institutes of Certified Public Accountants (HKICPA 2004) and Organization for Economic Co-operation Development (OECD 2004) provided a similar definition that corporate governance is coordination process between manager, board members, shareholders and stakeholders, and the organizational structures which drive the direction, operation and the monitoring the corporation for achieving the organizational objectives. Abdullah and Valentine (2009) provided a boarder definition for corporate governance and defined it as processes of managerial decisions making and a set of rules of management for both economic and non-economic activities carried out by the corporation. 2.2 Models of Corporate Governance The efficacy of corporate governance depends on the four major types of governance practice models adopted by corporations worldwide (Bhasa 2004): Market-centric governance model Under the market-centric governance style, scattered shareholders cannot control the firm. They are distanced from the management due to their equity ownership diffusion. There is strong and liquid capital market with good protection for shareholders. While this model benefits the collection of capital and spreads out risks of shareholders, scandals in worldwide companies show the deficiency of such a model. Relationship-based governance model Under the relationship-based governance model, banks are the dominant shares owner of a corporation. The banks have long term contractual relationship with the firms and directly control the daily managerial functions. The model is further characterized by weak and illiquid capital markets and excessive government intervention. Transition governance model The transition governance model is applied in corporation which is previously state-owned but now becomes a private corporation. Therefore the ownership structure of that corporation becomes fractioned. Unless retail investor can hold any shares ownership, the capital market is still weak and illiquid. Emerging governance model There is less researchers who study for the emerging governance model. It is only certain that this type of governance model is replicating the governance models of successful economies. 2.3 Theoretical framework There had been wide discussion on the issue of separation of ownership and control of corporation in prior research (Boubakri et al. 2008). Two major theories were used to explain this issue. Where the agency theory on one hand presented a divergence of interests of agent and principal, and stewardship theory on the other hand demonstrated alignment of those interests (Davis et al 1997). Mallin (2007) suggested several theories would influence the development of corporate governance, namely agency theory, stakeholder theory and stewardship theory. 2.3.1 Agency Theory Jensen and Meckling (1976) famously described the relationship between shareholders and managers as pure agency relationship. The shareholders (principal) owned and acquired ownership of the corporation and maximized their returns with the assist of agents, who serve the shareholder interests and control the corporation. According to the idea of Walsh and Seward (1990), organization would lose competitive advantages and would be unable to continue if managers act adversely with the shareholders aspiration (Davis et al. 1997). The agency problem occurred when there is a lack of attention to maximize shareholder returns, i.e. self-interested opportunism, where the principal is affected by the self-interest of their agents (Davis et al. 1997). Prior research has suggested two control mechanisms to solve the agency problem. They are the alternative executive compensation schemes and governance structures that can maximize shareholders wealth and guide the agents behavior (Demsetz and Lehn 1985; Jensen and Meckling 1976; and Davis et al. 1997). It is proved that agency costs have affected the means and mechanisms of corporation governance (Hutchinson and Gul 2003). They are incurred for providing incentives and compensations for managers and monitoring their conducts in order to prohibit individualism of managers (Roberts 2005). Researchers had suggested that there are limitations associated with agency theory. It assumed divergence of interests resulted from individualism of managers which in reality may not be appropriate to be applied to all agents (Doucouliagos 1994 and Davis et al. 1997). Moreover, Jensen and Meckling (1976) stated that controls of agency only provide potential profits that please shareholders, instead of ensuring the shareholders wealth are maximized. According to Donaldson and Dais (1991), Psychologist Douglas McGregors Theory Y can be applied to agents (Roberts 2005). Under the Theory Y, agents can exercise self control and are willing to act upon their principals interests. Therefore it shows the agency theory deficiency that managers are assumed to be self-serving. 2.3.2 Stewardship Theory According to Donaldson and Davis (1989, 1991), stewardship theory is introduced as a means of defining relationships based upon other behavior premises which is opposed to the agency theory (Davis et al. 1997). Mallin (2007) explains that stewardship theory draws on the assumptions underlying agency theory. The agency theory assumes that both agent and principals enjoy maximize their own utility. Therefore corporation is controlled by independent board and various committees. However under stewardship theory, the manager behaviors are assumed collective that they act upon principals interest. Therefore managers are given autonomy to attain the objectives of the corporation without intense control from owners. With regard to the stewardship theory, organizational structure is supposed to facilitate effective action by the managers and directors and to help them to formulate and implement plans for better corporate performance. However, the theory has never been used empirically to directly explain agents compensation or as an underlying theory (Hengarrtner 2006). 2.3.3 Stakeholder Theory Different from the agency theory and the stewardship theory, the stakeholder theory applies to a wider context that give thought to a group of people such as employees, customers, government, creditors and general public, other than just the shareholders. Moreover, corporations strive to maximize shareholders value together with the aim to care about the interests of stakeholders (Mallin 2007). Jensen (2001) stated there are theorists oppose to stakeholder theory because it aims to address the interests of all stakeholders which may not be logically possible and theorists provided no explanations of how to trade-off against those interests. To solve problems that arise from multiple objectives that accompany traditional stakeholder theory, value maximization becomes the most important interest of a corporation (Jensen 2001). 2.4 Importance and Contributions of Corporate Governance Even many of the corporate failures are the results of managerial fraud or accounting problems, corporation and regulator are focused on the corporate governance issue rather than the accounting standards and audit procedures (Green and Graham 2005). Corporate governance contributes to the well-governed corporation: increase in firms value with higher profitability and lower cost of investment of shareholders (Brown and Caylor 2005; Ashbaugh et al. 2004). Corporate governance is important because it can enhance accountability and transparency for stakeholders and can ensure corporations meet the needs of the general public (Tze and Chi 2006; Baker and Powell 2009). Furthermore, the corporate governance mechanism can minimize agency cost and avoid reduction of firms market value resulted from managers opportunism (yvind et al. 2004). One potential addition is that corporate governance can protect minority interest as it prevents manipulation of dominant shareholders (Merson 2010). Prior researcher had designed methodology and carried out empirical analysis in 30 countries for investigating the contribution of corporate governance, and it is found that better governance report enhance productivity of factors of production and economic growth (Aksu and Kosedag 2005; Sadka 2004). At the national level, good corporate governance practices attract more worldwide investors (Cheung and Jang 2008). 2.5 Relationship to research questions 2.5.1 Corporate Governance Disclosure Over the last decade, most economies require mandatory corporate governance disclosure while public organizations encourage a certain degree of voluntary disclosures (Ho and Wong 2001). For example, the Hong Kong Society of Accountant, Hong Kong Institutes of Certified Public Accountants and Corporate Governance Asia Magazine provided the best corporate governance disclosure awards to recognize the effort put on governance disclosures. To disclose useful and adequate corporate information to investors is important for all corporations as this is socially desirable. However, the extent of corporate governance disclosure is subject to the benefits and costs associated (Ho and Wong 2001; Green and Graham 2005; Hossain 2008). Another governance disclosure problem is that disclosures are ritualistic and opportunistic (Neu et al. 1998; Eng and Mak 2003; Young 2003; Green Graham 2005). Nevertheless, Green and Graham (2005) suggested that governance disclosure is important because corporations can be benefited by improving market valuation, increasing market liquidity, obtaining shareholders support and avoiding government intervention. For shareholders and investors, adequate disclosures ensure they can access the stewardship of management and make appropriate decisions. Also for the community, adequate governance disclosures assist public to understand the structure, activities, and both financial and social performance of corporations (Hong Kong Society of Accountant 2001). 2.5.2 Development of Corporate Governance in Hong Kong Since the Asian financial crisis in 1997, Asian government including Hong Kong became awareness of the important of corporate governance issue (Ho and Wong 2001). For public companies, there is not any governance rule. But for listed corporation, there are governance code and legal rules which requires a serious of governance practices. They include the needs to appoint non-executive directors, form board of directors and various committees, separate the role of chairman of board and the CEO (Lau and Young 2006). Listed companies are regulated by three-tier: namely (1) Companies Ordinance, Securities and Futures Commission (SFC) Ordinance and the Listing Rules administered by the Hong Kong Exchanges and Clearing Limited (Hong Kong Exchanges and Clearing Limited 2008). More importantly, from January 2005 onwards, the Code on Corporate Governance Practices has become effective. A listed corporation is required to act upon the Code Provisions on five aspects: directors; remuneration of directors and senior management; accountability and audit; delegation by the board; and communication with shareholders (Lau and Young 2006). According to the Appendix 14 Code on Corporate Governance Practices of the Listing Rules, listed corporations are responsible for disclosing in the interim and the annual report whether or not they complied with the Code of Provisions. Apart from this, there is guidance from corporation to exercise the recommended best practices. Even there is recommended best practices, many Hong Kong listed companies only comply with minimum corporate governance disclosure requirements of Listing Rules and accounting standards (Ho and Wong 2001). There are also irregular disclosure of governance information in the annual reports and publications (Green and Graham 2005). 2.5.3 Measuring Mandatory Governance Disclosure To measure the disclosure behavior of companies, there are three rating methods: (1) Credit Lyonnais Securities Asia (CLSA), (2) Standard Poors (SP), and (3) FTSE ISS (ISS) (Doidge et al. 2007). Prior researchers showed that these ratings analyze objectively and without bias information of companies governance practices, but CLSA only focused on less-developed and newly emerging countries and ISS on the other hand covered developed countries (Doidge et al. 2007). 2.5.4 Measuring Voluntary Governance Disclosure Prior researchers measured voluntary corporate governance disclosures by creating a system of calculating disclosure score for each company (Eng and Mak 2003). The extent of voluntary disclosures can be also found out by using relative disclosure index together with the disclosure checklists suggested by Ernst Young (Ho and Wong 2001). 2.5.5 Corporate Governance Relationship with Firm Performance Over the last decade, there is great increasing number of studies concerning the impacts of corporate governance. The question of whether or not corporate governance brings about the problems of managerial fraud and misconduct, misuse of powers, negligence, corporate failure, corporate collapse, losses of shareholder wealth and social irresponsibility, has been concerned by the public (Baker and Powell 2009; Merson 2010). The Asian financial crisis of 1997 was the result of poor corporate governance and low transparency of corporations (Ho and Wong 2001). The weak corporate governance regulation, useless governance principles and ineffective board and internal control have a deep impact on financial crisis. These lead to several corporate collapse, especially the collapse of Lehman Brothers in 2008 (Kirkpatrick 2009). According to Cheung, Connelly, Limpaphayom, and Zhou (2007), firm value is higher in the better governed firm (Cheung and Jang 2008). Klapper and Love (2003) concluded that good governance produced better operating performance as measured by return on assets and higher market valuation as measured by Tobins Q. Apart from these, according to Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen and Ferrell (2004), it is found that the better corporate governance is, the better the corporate performance (Bhagat and Bolton 2008). However this is not the only finding. There are different views about the relationship between corporate governance and corporate performance: First, there is lack of evidence which proved a linkage between governance practices and subsequent performance of corporation (Nelson 2004; Bhagat and Bolton 2009). Second, there is only positive relationship in theory, but in fact researchers found reverse result because these researchers did not consider the unique organizational environment of corporations (Hutchinson and Gul 2003). For example, in case a firm has high growth potential, better performance will be resulted even if there are poor corporate governance practices. Besides, Hutchinson and Gul (2003) demonstrated that not only corporate governance practices can significantly affect the corporate performance, but in fact performance can affect the governance practices. Third, prior to 2002, Bhagat and Bolton (2009) suggested even there are good governance practices; there may not good corporate performance. This is the same result of the study of Young (2003). But Bhagat and Bolton (2009) have found a positive relationship between board independence and operating performance after year 2002. Besides, it was found by Daily and Dalton (1994) that fewer number of independent non-executive directors in board causes bankruptcy and failure of a corporation (Elloumi and Gueyie 2001) although Young (2003) suggested there is no relation between board independence and four measures of firm performance. Also, the combined role of the CEO and the board chairman causes a greater chance of financial distress (Elloumi and Gueyie 2001). Furthermore, the relationship may be subject to the factor of investment opportunities. If a corporation has more investment opportunities, managers opportunistic behavior is more difficult to monitor and thus poor performance may be resulted (Hutchinson and Gul 2003). Hypotheses setting An objective of this study is to investigate whether or not companies with good governance would have better performance. Three variables are examined in this study, including operating performance, financial performance and stock market performance. Hypothesis 1: Corporations with higher corporate governance score are more likely to have better operating performance as measured by accounting indicators (financial risk and operating risk). Hypothesis 2: Corporations with higher corporate governance score are more likely to have higher financial performance as measured by accounting indicators (liquidity, and profitability). Hypothesis 3: Corporations with higher corporate governance score are more likely to have better market performance as measured by market capitalization.