The impact of corporate governance on firm performance, the case of listed companies in vietnam

University of Economics International institute of Social Studies Ho Chi Minh City, Vietnam Erasmus University of Rotterdam The Netherland VIETNAM- THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF CORPORATE GOVERNANCE ON FIRM PERFORMANCE: THE CASE OF LISTED COMPANIES IN VIETNAM By Nguyễn Minh Trí A thesis submitted in Partial fulfillment of the Requirements for the Degree of Master of Art in Development Economics Under the supervision of Dr Võ Hồng Đức Vietnam - Netherlands Programme, November 2013 DECLARATION It is to certify that this thesis entitled “The impact of corporate governance on firm performance: the case of listed companies in Vietnam” meets all requirements for the Master Degree of Art in Development Economics This thesis and all contents presented in it are developed by me as my own original research It is neither in part nor in whole been presented for another degree elsewhere Nguyễn Minh Trí (Author’s name) (Signature) (Date) The above declaration is affirmed Dr Võ Hồng Đức (Supervisor’s name) (Signature) (Date) Page ii ACKNOWLEDGE First and foremost, I would like to thank my supervisor, Dr Võ Hồng Đức, an expert in corporate finance for his advice, guidance and support My thesis could not be completed without his invaluable feedback and comment about the theory, data and research methodology I would like to express my sincere gratitude to all lectures of Vietnam – Netherlands program for their knowledge and provide me opportunity to study this topic Special thanks to Dr Trương Đăng Thụy and Dr Lê Văn Chơn, who support me in using econometric models in this thesis Furthermore, I would like to thank my friends, who have controversial discussions with me about my topic and provide some contribution for my thesis Last but not least, I would like to send many thanks to my family, who support to me in both physical and mental extent during my thesis process Page iii ABSTRACT This empirical research is conducted to examine the relationship between corporate governance and firm performance In this study, corporate governance is proxied by a set of variables, including a dual role of the CEO, board’s size, board independence and ownership concentration In addition, firm performance is measured by four different methods which are (i) return on asset (ROA), (ii) return on equity (ROE), (iii) Z-score by Altman (1968) and (iv) Tobin’s Q Using the Feasible Generalized Least Squares (FGLS) on the dataset of 177 listed companies in Vietnam for the period of years, from 2008 to 2012, the findings of this study indicate multiple effects of corporate governance on firm performance First, duality role of the CEO is positively correlated with firm performance Second, there is a structural relationship between managerial ownership and firm performance Third, board independence has opposite impacts on firm performance Fourth, this study however fails to provide an empirical evidence support the statistically significant relationship between board size and firm performance Key words: corporate governance, firm performance, listed companies, Vietnam Page iv LIST OF CONTENTS CONTENTS Page DECLARATION ii ACKNOWLEDGE iii LIST OF FIGURES vii LIST OF TABLE vii LIST OF ABBREVIATIONS vii CHAPTER 1: INTRODUCTION 1.1 Problems statement 1.2 Research objectives: 1.3 Research question: 1.4 Research scope: 1.5 Research methodology 1.6 The structure of this thesis CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical review 2.1.1 Legalistic perspective 2.1.2 Resource dependence 2.1.3 Class Hegemony 2.1.4 Agency theory 2.1.5 Stewardship theory 11 Page v 2.2 Empirical review 14 2.2.1 CEO duality and firm performance 14 2.2.2 Board independence and firm performance 17 2.2.3 Ownership concentration and firm performance 22 CHAPTER 3: 28 DATA AND METHODOLOGY 28 3.1 Data 28 3.2 Variables 29 3.2 3.2.1 Dependent variables 29 3.2.2 Independent variables 33 3.2.3 Control variables 35 Methodology 37 CHAPTER 4: 39 DATA ANALYSIS AND EMPIRICAL RESULTS 39 4.1 Data statistics 39 4.2 Results 44 4.2.1 Empirical results by OLS 44 4.2.2 Empirical results by FGLS 45 CHAPTER 5: 50 DISCUSSIONS 50 CHAPTER 6: 54 CONCLUSIONS AND IMPLICATIONS 54 REFERENCES 56 Page vi LIST OF FIGURES Figure 1: Board’s role and attributes 13 Figure 2: Analytical framework 27 Figure 3: Correlation between CEO’s ownership and firm performance 40 Figure 4: Correlation between Board’s ownership and firm performance 41 LIST OF TABLES Table 1: A summary all variables used in this study: concept and measurement 36 Table 2: Descriptive statistic of variables 39 Table 3: Correlation matrix among variables 43 Table 4: the results by using pooled OLS 44 Table 5: Tests of heteroskedasticity and autocorrelation 45 Table 6: The results by using FGLS 47 LIST OF ABBREVIATIONS ROA : Return on asset ROA : Return on equity ROI : Return on investment CEO : Chief Executive Officer OLS : Ordinary Least Square FGLS : Feasible Generalized Least Square Page vii CHAPTER 1: INTRODUCTION Ho Chi Minh City Stock Exchange (HOSE), established by the Decision 559/QĐTTG of Prime Minister dated 11 May 2013 in Vietnam, was previously considered as the Ho Chi Minh City Stock Center Until 2012, HOSE has 342 listed firms including 301 stocks, institutional fund certificates and 38 bonds Total volume of share and listed value is more than 26.7 billion shares and 273 trillion VND respectively The HOSE is considered as a high liquidity market with total market capitalization of 678 trillion VND (32.6 billion USD) by the end of 2012 This figure accounted for 24 percent of the national GDP Moreover, the average of transaction value in 2012 was 890 billion VND, an increase of 39 percent compared to that in 2011 During a recent global financial crisis in 2008/2009, HOSE still achieved positive results (Source: HOSE’s website) 1.1 Problems statement Corporate governance focuses on the structures and processes for the business direction and management of firms It involves the relationships among company’s controlling system, roles of its board directors, shareholders and stakeholders Williamson (1988) considered that the corporate governance has relation with transaction cost and, in turn, enhances firm performance In addition, weak corporate governance reduces investor confidence and discourages outside investment Similarly, Bhagat and Page Bolton (2008) undertook a research on the endogenous relationship between corporate governance and firm performance and concluded that good corporate governance affects positively to performance For developing countries, board of directors plays an important role in improving firm performance in order to serve public objectives In Vietnam, the framework of corporate governance has just been in an early stage of development There are not many laws regulating corporate governance in Vietnam based on different types of companies Consequently, some shortcomings occur in corporate governance situation in Vietnam In academia, the corporate governance in Vietnam has been approached in many angles of law and legal consideration by Nguyen (2008), qualitative model by Le and Walker (2008) and quantitative approach by Vo and Phan (2013a,b,c,d) Various empirical studies by Vo and Phan can be considered groundbreaking studies on the examination of the relationship between corporate governance and firms’ performance In their studies, there is a positive relationship between CEO duality, experience and compensation to firm performance However, board’s size and firms’ performance are negatively correlation in their studies Vo and Phan also concluded that there is an existence of the nonlinear relationship between board’s ownership and firm performance In another study, Vo and Phan (2013) examined the effect of corporate governance to firms performance through a gender of board members This study confirmed the role of female board members to improve firms’ performance In addition, Vo and Phan (2013) also introduced a new method in which an interaction of variables Page between the CEO duality and growth opportunity is considered Especially, another study of Vo and Phan (2013) is considered as full version of corporate governance because it referred most of important elements of corporate governance affecting to firm performance Various empirical studies on corporate governance and firms’ performance in Viet Nam consecutively conducted by Vo and Phan have confirmed that this important issue in terms of research and practice has not attracted significant attention of research community in Vietnam in the past However, even though Vo and Phan’s studies have covered a wide range of issues in relation to corporate governance, their estimation for firms performance is relatively constrained As a result, the importance of the topic on corporate governance and a relaxation of restriction on the measurements of firms’ performance has motivated me to conduct this study to provide another empirical evidence on the issue for a further debate 1.2 Research objectives: The objective of this study is to empirically examine the relationship between corporate governance and firm performance in term of three components: duality, board composition and ownership concentration 1.3 Research question: What is the relationship between corporate governance and firm performance? Page Source: Author’s calculation Table below shows the test results for two most moderate problems in regression models: heteroskedasticity and serial correlation The panel A indicates that the all models contain heteroskedasticity because the Prob Chi-Square is 0.000, whereas Panel B presents autocorrelation happens in equation (1) and (2) Table 5: Tests of heteroskedasticity and autocorrelation Panel A Breusch-Pagan / Cook-Weisberg test for heteroskedasticity Equation (1) Chi-square Prob > Chi-square Equation (2) Equation (3) Equation (4) 90.180 6.530 5607.060 261.190 0.000 0.010 0.000 0.000 Panel B Breusch-Godfrey LM test for autocorrelation Equation (1) Chi-square Prob.> Chi-squared Equation (2) Equation (3) Equation (4) 20.334 52.621 0.395 0.245 0.000 0.000 0.529 0.621 Source: Author’s calculation 4.2.2 Empirical results by FGLS Because of some shortcomings of OLS model, Feasible Generalized Least Square (FGLS) is developed to regress a dependent variable on independent variables The disadvantage of OLS is that the coefficient is bias if the model contains heteroskedasticity and/or autocorrelation For OLS with random effect or fixed effect, the assumption of this model is that covariance between independent variables and the error term is zero Wooldridge (2002) considers that the FGLS has more advantages than pool OLS or OLS with fixed effect or random effect (the two popular models in Page 45 economic researches) Therefore, for FGLS, it is more appropriate for panel data than OLS in case of occurrence of heteroskedasticity, serial correlation or non-zero covariance between independent variable and error term In data statistic section, it is expected that there is a structural relationship between managerial ownership and firm performance Therefore, in order to test it, I put more two dummy variables: DOWNCEO (coded “1” if CEO’s ownership is higher than 30% and “0” for other cases) and DOWNBOARD (coded “1” if board’s ownership is higher than 35% and “0” for other cases) The new system of models is as follows: Model (5) = α0 + + + + + + + + + Model (6) = α0 + + + + + + + + + Model (7) = α0 + + + + + + + + + Model (8) = α0 + + + + + + + + + Page 46 Table 6: Results by using FGLS Dependent variables Independent variables ROA ROE Q ZSCORE ROA ROE Q ZSCORE Model (1) Model (2) Model (3) Model (4) Model (5) Model (6) Model (7) Model(8) 1.726 ** 1.533 0.635 0.133 - 0.135 * - 0.196 * 0.039 - 0.037 * SIZE 0.232 0.409 0.426 - 0.076 OWNBOARD 0.058 ** 0.107 ** - 0.017 0.028 * - 7.767 ** 3.804 * DUAL OWNCEO INDE - 3.220 1.579 SALE 0.000 0.005 0.000 0.000 DOWNCEO DOWNBOARD 0.755 0.283 0.943 - 0.049 0.331 0.536 0.387 - 0.057 - 4.467 - 0.149 0.000 0.005 - 7.558 *** 3.502 * 0.000 0.000 - 3.019 *** - 5.615 *** - 1.123 - 1.291 ** 2.151 ** 4.965 ** 1.488 1.296 * 0.141 0.872 TURNOVER 0.864 1.846 0.123 0.851 0.979 2.006 dumindu Industry Industry Industry Industry Industry Industry Industry Industry control control control control control control control control * denotes significant level at 1% ** denotes significant level at 5% *** denotes significant level at 10% Source: Author’s calculation Page 47 Impact of CEO characteristic on firm performance Table shows the CEO duality has positive correlation to firm performance measured by ROA with confident level at 95% Although in term of ROE, Tobin Q and Z-score model, duality does not show significant result, the sign of coefficient in all of cases is positive This result supports the stewardship theory like Boyd (1995) which refers that the separation of CEO and chairperson leads to the bad performance for company Impact of board independence on firm performance Two factors, which I use to estimate board independence in above models are board’s size and proportion of independent members over total members The table shows board size does not affect to firm performance including four measurements For other explanatory variable – proportion of independent directors, there is a significant association on Tobin’s Q and Z-score in two directions For Tobin’s Q, It is negative and for Z-score, it is positive The significant level is 5% and 1% respectively The interesting finding in this model is that board independence only influence firm performance, which is measured by the methods relating market value of equity For accounting estimations like ROA, ROE, they present insignificant results Impact of ownership concentration on firm performance It seems that the ownership only affects firm performance through measurements relating to accounting Model (1), (2) and (4) indicate that board’s ownership has positive Page 48 supporting of this factor to ROA, ROE and Z-score Particularly, the coefficient is very highly significant at 5% and 1% However, with the same result of Demsetz and Villalonga (2001), my study finds out no evidence to conclude the relation between ownership and Tobin’s Q although I solve problem of firm specification by putting dummy variables In addition, the results also present the amazing result that the CEO is not promoted by share value It is proved by negative coefficient of CEO’s ownership in three measurements of financial performance: ROA, ROE and Z-score with very high significance of 1% The new finding in this research is that there is a structural change between managerial ownership and firm performance Model (6), (7) and (8) present the positive effect of CEO’s ownership on firm performance when percentage of share held by CEO is in range of 0% and 30% After that, the increase in ownership makes firm performance decrease slightly The significant levels are 10%, 10% and 5% for ROA, ROE and Zscore respectively In contrast, firm performance decreases when board’s share increases from 0% to 35% However, at higher ownership level, the performance increases This result has high confident degree at 95%, 95% and 99% for ROA, ROE and Z-score in that order Page 49 CHAPTER 5: DISCUSSIONS The study provides empirical evidence to support for the positive relationship between the CEO duality and firm performance measured by ROA Although for ROE, Tobin’s Q and Z-score measures, this impact is insignificant but the sign of all coefficients is positive This result supports the stewardship theory in which the role of CEO as chairperson is emphasized to control firms more effectively In particular, Davis, Schoorman and Donaldson (1997) explored the mechanism of duality’s impact on firm performance CEOs are interested in the intrinsic value including achievement and motivation, which is not influenced by market stock value Moreover, being CEO as chairperson helps the CEO understand more on an entire business of company and makes good decisions It explains that why dual situation associates positively with firm performance For board composition, this study fails to provide evidence to support the relationship between board’s size and firm performance in all four measures of firm performance The findings from this study are different with those from previous studies including Eisenberg, Sundgren and Wells (1997) study which confirmed that there is a negative correlation between board size and firm performance and Muth and Donaldson (1998) stressed the role of board in reflecting the internal and external business environment These researches also believed strongly that there exists an optimal size of Page 50 board depending on the particular circumstance in each company because it shows the good complement between inside and outside directors The finding from this study is similar with conclusion of Bhagat and Black (1999) who concluded that there is no persuadable evidence to confirm that an increase of board size enhances firm performance It may be the case that, for the relationship between board’s size and firm performance in Vietnam, board size does not reflect its role in managing companies It has not caused any effects for firm profitability In term of market value of stock, the board independence in this study indicates the negative effect on firm performance estimated by Tobin’s Q This result is similar with Klein (1998) study which appreciated the role of inside directors Market value represents the reaction of investors to the change of information relating to corporate governance and firm performance In the Vietnamese stock market, investors usually react negatively to the change in top-tiered management of companies because they assume that bad problems are the main causes for these changes First, perhaps the unreasonable mix of inside directors and independent members makes the board difficult to control firms Second, there is no complement and cooperation between executive and non-executive in the board Third, the larger board size usually includes many independent members from larger shareholders Because they are non-executive, they cannot understand clearly the company’s situation The wrong decision may be made from the board However, in the empirical conclusion of this study with Z-score, the market value of stock is just one component of a set of financial ratios in estimating firm Page 51 performance In this case, the independent board indicates the positive relationship with firm performance as proxied by Z-score This presents that finding that the board independence makes firm performance better in term of accounting For ownership concentration, the finding from this study supports the view of Abidin, Kamal and Jusoff (2009) that there is a negative effect of CEO’s ownership on firm performance In Vietnam, the shares not promote the CEO in managing and improving performance because percentage of share owned by CEO is relatively low Moreover, the stock market in Vietnam from 2008 to 2012 indicates the distressed period following the global financial crisis in 2008/2009 As such, the profit from stock is not significant In addition, the low ownership leads to the weak voting right of CEO in annual meetings of board of directors This cannot stimulate the ability of CEO However, this study suggests that it should keep CEO’s ownership lower than 30% because the CEO’s ownership has negative effect on firm performance when share level is higher than 30% After that, the firm performance goes down This conclusion is similar with the finding from Short and Keasey (1998) indicating the alignment of interest between CEO and firm performance at low level of share and entrenchment at high level For the board, the main finding of this study is an existence of a structural change between board’s ownership and firm performance In more details, the impact of this factor is contrary to CEO’s ownership It means that board’s share is negatively affected on firm performance when ownership increases from 0% to 35% and then, firm Page 52 performance increases when ownership increases The interpretation for this relation is that on one hand, at a low level of ownership, the board of directors has made bad decisions for developing firms On the other hand, at a higher level, the results support the stewardship theory that Davis, Schoorman and Donaldson (1997) presented that board members act for firms’ benefits when they have strong relation with firms through ownership This decreases transaction cost and increases operating efficiency The interests of the board and firms are aligned, and this match of the interests makes firm performance worse However, the decreasing level of performance is lower than increasing stage, so in overall, the percentage of share associate positively to financial performance as stated on model (1), (2) and (4) Page 53 CHAPTER 6: CONCLUSIONS AND IMPLICATIONS The main findings of this study present various effects of corporate governance on firm performance First, the research supports a stewardship theory which confirms the role of CEO as chairperson in improving firm performance Second, CEO’s ownership and board’s ownership have structural relationship with firm performance In details, when the CEO’s ownership goes up from percent to 30 percent, there is a reduction in firm performance After that, when CEO’s ownership increases above 30 percent, this increase leads to an improvement of firm performance In contrast, the relationship between board’s ownership and firm performance has inversed U-shape with the peak at 35 percent of ownership Third, this empirical study fails to provide an empirical evidence to confirm the significant relationship between the board’s size and firm performance Final, the most interesting finding of this study is that the board independence, as measured by proportion of independent members, has different impacts on firm performance in different measures The empirical research suggests solutions for listed companies in enhancing firm performance through improving corporate governance Based on the empirical results, the lessons for corporate governance are proposed The listed companies should focus on the role of CEO in managing and monitoring companies The CEO should ideally be as chairperson in the board In addition, the study presents that a low level of ownership Page 54 does not encourage the CEO to improve firm performance; as such, board of director should compensate CEO by shares rather than by cash The ownership represents to the voting right The CEO with higher voting right will make good decisions for firm performance For board of director, its ownership should keep lower because at this level, the interests of board director and companies are aligned Although this empirical study provides some valuable findings in the relationship between corporate governance and firm performance, it also experiences some limitations First, the period time of this sample is rather short, only from 2008 to 2012, so the result does not refer to the effect of corporate governance in the long - run Second, the period selected may not be a good representative period As such, the impact of corporate governance on firm performance can be different in normal situation Third, for Tobin’s Q estimation, although it is the most popular ratio in previous studies, it seems inefficient in measuring firm performance and the market price does not reflect exactly firm value because: (i) the stock market in Vietnam is small and in early stage; (ii) the transparency of information and liquidity of stock market are low; and (iii) the scope of this study is between 2008 and 2012 – crisis period of Vietnamese economy Page 55 REFERENCES Journals Abidin, Z Z., Kamal, N M., & Jusoff, K (2009).Board structure and corporate performance in Malaysia International Journal of Economics and Finance, 1(1), P150 Altman, E I (1968) Financial ratios, discriminant analysis and the prediction of corporate bankruptcy The journal of finance, 23(4), 589-609 Baliga, B., Moyer, R C., & Rao, R S (1996) CEO duality and firm performance what's the fuss Strategic Management Journal, 17(1), 41-53 Barnhart, S W., & Rosenstein, S (1998) Board composition, 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http://thuvienphapluat.vn/archive/Thong-tu-121-2012-TT-BTC-quy-dinh-quan-tricong-ty-ap-dung-cho-cong-ty-dai-chung-vb145477.aspx Website HOSE’s website: http://www.hsx.vn/hsx/Default.aspx FPTS’s website: http://www.fpts.com.vn/ http://vietstock.vn/ Page 59 ...DECLARATION It is to certify that this thesis entitled ? ?The impact of corporate governance on firm performance: the case of listed companies in Vietnam? ?? meets all requirements for the Master Degree of. .. scope: The impact of corporate governance on financial performance of companies listed in Ho Chi Minh City Stock Exchange (HOSE) from 2008 to 2012 in Vietnam are considered In addition, firm performance... type of firm The impact of the board on financial performance occurs inside the company through the influence on strategic initiatives by creating the concept and framework for good business