Corporate Governance by Daley Mok (2/7)

Independent Directors and Corporate Financial Performance – A Hong Kong Perspective (A DBA Dissertation Completed in August 2005)

Table of Contents, Abstract and Acknowledgements

Table of Contents

Declaration. i

List of Tables and Figures. v

Abstract vi

Acknowledgements. viii

Chapter 1 – Introduction. 1

1.1         Background. 1

1.2         The Corporate Governance Arena. 1

1.3         Corporate Governance Reform with Independent Directors. 3

1.4         The Nature of the Firm.. 3

1.5         Research Question. 4

1.6         Delimitations and Assumptions. 6

1.7         Structure of the Dissertation. 6

Chapter 2 – Literature Review.. 8

2.1         Corporate Governance Defined. 8

2.2         A Theoretical Framework for Corporate Governance. 8

2.2.1      Agency Theory. 9

2.2.2      Stakeholder Theory. 10

2.2.3      Stewardship Theory. 11

2.2.4      Trusteeship. 12

2.2.5      Organisational Trust 12

2.2.6      The Prevalent Corporate Governance Theory. 12

2.2.7      The Role of Corporate Governance. 13

2.2.8      Definitions of Independent Director and Independent Board. 13

2.2.9      The Roles of the Board. 14

2.2.10    Classifications of Directors in the US. 15

2.2.11    Classifications of Directors in Hong Kong. 17

2.3         Previous Research – Impact of Corporate Governance on Performance. 17

2.3.1      Advocacy By Capital Providers. 17

2.3.2      The Impact of Independent Directors in the US – Empirical Evidence. 18

2.3.3      The Impact of Independent Directors Outside the US – Empirical Evidence. 20

2.4         Regulatory Framework for Independent Directors. 21

2.4.1      Definitions of Independent and Independence. 21

2.4.2      Board Composition Regulatory Framework – An Overview.. 22

2.4.2.1   US. 22

2.4.2.2   UK.. 23

2.4.2.3   Australia. 23

2.4.2.4   Japan. 24

2.4.2.5   Hong Kong. 24

2.4.2.6   The People’s Republic of China (PRC) 25

2.4.2.7   Independence pot-pourri 25

2.5         The Hong Kong Marketplace. 26

2.5.1      Characteristics of Hong Kong Listed Companies. 26

2.5.2      Hong Kong Compared with Other Countries. 27

2.5.3      Hypotheses. 28

Chapter 3 – Research Methodology. 32

3.1         Research Question Revisited. 32

3.2         Research Methodology in General 32

3.3         Research Method and Sample Selection. 37

3.3.1      Research Design. 38

3.4         Hypotheses and Sampling Design. 40

3.4.1      Hypothesis 1. 40

3.4.2      Hypothesis 2. 41

3.4.3      Hypothesis 3. 42

3.5         Key Assumptions in Research Design. 42

Chapter 4 – Analysis. 44

4.1         Summary of Sampling Results. 44

4.2         Hypothesis 1. 45

4.2.1      Preliminary Scatterplots. 45

4.2.2      Preliminary Descriptive Statistics. 47

4.2.3      Preliminary Linear Regression Analyses. 48

4.2.4      Sample Without Outliers. 50

4.2.5      Scatterplots. 50

4.2.6      Descriptive Statistics. 51

4.2.7      Linear Regression Analyses. 52

4.3         Hypothesis 2. 55

4.4         Hypothesis 3. 56

Chapter 5 – Conclusion. 59

5.1         Interpretation of Findings. 59

5.1.1      General 59

5.1.2      Growth-orientation of Company. 61

5.1.3      Shareholder Background of Company. 61

5.2         Policy Implications. 62

5.2.1      General 62

5.2.2      Relevance of Findings to Existing Regulations. 64

5.2.3      Recommendations to Policy Makers. 64

5.3         Generalisability of Results. 66

References. 68

 

List of Tables and Figures

Table 4.1         Sample Composition                                                                                  

Table 4.2         Descriptive Statistics of the Whole Sample                                               

Table 4.3         Preliminary Linear Regression Results                                                      

Table 4.4         Sample Composition Without Outliers                                                      

Table 4.5         Descriptive Statistics of the Whole Sample Without Outliers                   

Table 4.6         Linear Regression Results                                                                          

Table 4.7         Linear Regression Results Satisfying Regression Assumptions                

Table 4.8         Z Test between Growth-Oriented Companies and Non-Growth-Oriented Companies                                                                                                                    

Table 4.9         Z Test between Companies Majority-Owned by Mainland Chinese Interests and Companies Majority-Owned by Non-Mainland Chinese Interests            

Figure 4.1        Scatterplots of the Whole Sample                                                              

Figure 4.1A        ROE versus % of NEDs                                                                       

Figure 4.1B        ROA versus % of NEDs                                                                       

Figure 4.1C        P/E versus % of NEDs                                                                          

Figure 4.1D        MV/BV versus % of NEDs                                                                  

Figure 4.2        Scatterplots of the Whole Sample Without Outliers                                  

Figure 4.2A        ROE versus % of NEDs                                                                       

Figure 4.2B        ROA versus % of NEDs                                                                       

Figure 4.2C        P/E versus % of NEDs                                                                          

Figure 4.2D        MV/BV versus % of NEDs                                                                  

Abstract

In recent years there have been a number of high-profile corporate failures worldwide. Though attributable to myriad causes, these corporate fallouts appear to have evoked a convergence on one main issue – poor corporate governance (CG). As a result, there has been a growing global awareness of the importance of CG, leading to promulgation of CG laws, regulations, listing rules and proliferation of codes of best practice.

Good CG has been argued to be capable of protecting the interests of the shareholders, as well as enhancing corporate financial performance. Indeed, each of the eleven institutional investors and two merchant bankers interviewed in a recent Hong Kong report (Tsui & Gul, 2003) believed that CG would lead to better firm performance in the long run.

One of the key CG principles lies with the role, powers and responsibilities of the company board. Despite variations in the CG schema, each seems to support the view that director independence and board independence are pivotal to good CG. Such a view is underpinned by the agency theory which explicitly considers a company’s managers to be the “agents” of the shareholders, the “principals”. This theory presumes that the monitoring role of the board of directors is key to good CG. The common perception is that outside representation on corporate boards, through the appointment of independent non-executive directors, can increase managerial monitoring and so improve firm performance. However, empirical evidence on the effectiveness of independent directors remains inconclusive. There is no unequivocal evidence that board composition is associated with company performance in the manner and to the extent so frequently claimed, particularly in tightly regulated markets like the US and the UK.

There is a paucity of such research in the Hong Kong context. Yet, the Hong Kong Stock Exchange ranks high internationally by market capitalisation, and its idiosyncratic features – dominance of family-owned companies and having an increasing presence of entities with mainland Chinese interests – make it a market of particular interest.

This study, sampling all companies listed in Hong Kong to run regression analyses, finds that the proportion or number of independent directors in the board of directors is positively associated with company financial performance; the relationship between board composition and company financial performance is stronger in growth-oriented companies than non-growth-oriented companies; and the relationship between board composition and company financial performance is stronger in companies majority-owned by mainland Chinese interests than companies majority-owned by non-mainland Chinese interests.

The research findings have a potential relevance not only to Hong Kong, but also to other markets with similar levels of governance regimes and especially so where companies’ affairs are exposed to the influence of dominant family-owned interests.

Acknowledgements

Several people have generously assisted in this study. First of all, I am grateful to an anonymous reviewer for his independent comments on the whole manuscript. Dr. Gian Casimir, helped tremendously in the initial stage when the dissertation topic was being nurtured. Dr. Casimir’s enlightenment on research methodology also proved very constructive. Above all, Emeritus Professor Frank Clarke, my supervisor, guided me industriously with insightful comments over every dissertation stage, section by section, chapter by chapter, leading to its final completion. This research would not be in its current shape without Emeritus Professor Clarke’s valuable input.

Family support was indispensable in continuing the many lonely hours of research, writing and re-drafting. If not primarily for setting an academic example for my two little children, Ryan and Doreen, I would not have pursued a doctoral study. I also need to thank my younger brother, James, for his unrelenting support over my difficult years. Finally, I must thank my wife, Rebecca, for giving me the opportunity to take precious time off the family. Without Rebecca’s stern insistence that I am capable of attaining a doctoral degree, this dissertation would never have been completed.