Research Question
Despite HK’s importance as a global financial center, and HKEX having high market capitalization with peculiar characteristics, there is a scarcity of research about the effect of board composition on firm performance in the Hong Kong context. The dominance of family-controlled companies and an ever-increasing post-1997 presence of entities with mainland Chinese interests make HKEX a market of particular interest. By revisiting a past research done by Mok (2005) using the latest market data, this study explores again the effect of board composition on firm performance for HK-listed companies to see if past findings are refuted. The primary focus is whether there are associations between the relative percentage and number of independent directors in a company board, and the company’s financial performance.
INEDs alone and combined with NEDs are picked to represent independent directors. In measuring corporate financial performance, both accounting ratios and market data are employed. Accounting ratios chosen include ROE and ROA, while price-earnings ratio (P/E) and market value per book value of equity (MV/BV) are used to proxy market performance. ROA is used in addition to ROE to minimize the impact of debt financing on profitability. As for market-based returns, P/E is widely used by market participants in reflecting market perception of firm value as well as growth potential, while MV/BV is an alternative measure commonly adopted by academics.
Methodology
The research process encompasses: compiling a list of all companies listed on the HKEX, followed by assembling secondary data in relation to outside board composition and company financial performance from etnet.com.hk, a reputable database of local company information. Then, linear regression tests are to be run using outside board composition as the independent variable and financial performance indicator as the dependent variable. Presetting a confidence level at 95%, statistical tools including r (correlation coefficient), p-value and z-value will be employed to identify if any significant relationship exists. To add reliability, as aforementioned, multiple definitions of outside board composition and financial performance indicator will be utilized. As far as practicable, distortions due to different operationalizations employed (Daily et al., 1999) will be minimized.
Over 60% of HK-listed companies have their year-end on the 31 December, with about 30% adopting 31 March. Our reference date was chosen to be 25 November 2021. While it allowed sufficient time for most companies to publish their latest annual reports (for the year ended 31 December 2020 to the year ended 31 March 2021) for the market to digest, it was not a month-end date that might attract manipulation due to month-end or quarter-end reporting. An official list of all listed companies as of the reference date was downloaded from the HKEX website. The list showed 2,210 companies on the Main Board and 364 on the GEM.
Hypotheses and Sampling Design
Hypothesis 1
HR1a proposes that a relationship exists between the percentage of independent directors in the board of directors and corporate financial performance.
All companies on the Main Board and the GEM were used in running a series of simple regression analyses. The Percentage of NEDs, an independent variable, was used to predict variation in ROE, the dependent variable, to see if any significant relationship exist. Three more replicate tests were done by substituting ROA, P/E, MV/BV respectively for ROE to add reliability.
For checking whether INEDs had greater impact on company performance than NEDs, another set of regression tests of the four performance measures was repeated using Percentage of INEDs instead of Percentage of NEDs. The two sets of tests were then compared to reveal whether HR1a holds.
HR1b suggests that a relationship exists between the number of independent directors in the board of directors and a firm’s financial performance.
As in assessing HR1a, two sets of regression tests, using the four performance measures, were undertaken. The only differences were changing relative to absolute measures, replacing Percentage NEDs with Number of NEDs in the first set, and Percentage of INEDs with Number of INEDs in the second.
Companies on the Main Board vary widely in size. Most are small to medium by global standards. To isolate the impact of company size, excluding CEs and CAs, companies of comparable market capitalization were grouped into large (over HK$10,000 million, or US$1,282 million), medium (between HK$10,000 million and HK$1,000 million, or US$1,282 million and US$128 million) and small (less than HK$1,000 million, or US$128 million). The aforementioned regression tests were repeated for each of the three size groups.
Hypothesis 2
The impact of independent directors on firm performance may be more pronounced in growth enterprises than otherwise. HR2 suggests that the relationship between board composition and corporate financial performance is stronger in growth-oriented companies than in non-growth-oriented companies.
Data relating to all the companies on the GEM and the Main Board, excluding CEs and CAs, were used in the testing of Hypothesis 2. Separate linear regression tests were run for the GEM companies and Main Board companies. Similar to Hypothesis 1, the two groups of variables used were – Percentage of NEDs, Percentage of INEDs, Number of NEDs, Number of INEDs; and ROE, ROA, P/E, MV/BV. By applying r-to-z transformation, the correlation coefficients of the two independent groups of companies were transformed into z-scores and compared to see if the difference was statistically significant.
In addition, companies with high MV/BV are often interpreted by the market to have high growth potential. For sensitivity analysis, companies from the Main Board group with high MV/BV were extracted for separate regression tests against those Main Board companies with low MV/BV. The results were then assessed if they were consistent with those of the GEM group against the Main Board group.
Hypothesis 3
Due to more westernized culture and management style, independent directors in companies majority-owned by non-mainland Chinese could possibly exercise greater control. HR3 presumes that the relationship between board composition and corporate financial performance is stronger in companies majority-owned by non-mainland Chinese than in companies majority-owned by mainland Chinese.
With insufficient CEs and CAs on the GEM to draw any representative sample, those on the GEM were grouped with those sourced from the Main Board in the testing of Hypothesis 3 – with separate regression tests for the CE group and CA group, using the same two groups of variables – Percentage of NEDs, Percentage of INEDs, Number of NEDs, Number of INEDs; and ROE, ROA, P/E, MV/BV. The results for CEs and CAs were then compared with those for non-CE and non-CA companies to isolate any noticeable differences in correlation.
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