Board Structure And Ownership In Malaysia

Transcription

1. Board structure and ownership in Malaysia : the case of distressed listed companies Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Shamsul Nahar Abdullah Shamsul Nahar Abdullah is an Associate Professor in the Faculty of Accountancy, Universiti Utara Malaysia, Kedah, Malaysia. Abstract Purpose – This study seeks to examine the influence of board independence, CEO duality and ownership structure on the firm financial distressed status using a sample of distressed companies and a matched-pair sample of non-distressed companies listed on the Bursa Malaysia. Design/methodology/approach – This study utilized publicly available data from annual reports of a sample of 86 non-finance distressed firms listed on the Bursa Malaysia and a sample of matched 86 non-distressed firms for a period covering the 1999-2001 financial years. Findings – Board independence and CEO duality are not associated with financial distressed status. Management and non-executive directors’ interests are associated negatively with financial distress. A negative association is also documented for outside blockholders. The evidence also supports the contention that ownership by non-executive directors and outside blockholders effectively increases their incentives to monitor management in ensuring their wealth in the firms is intact. Research limitations/implications – One limitation of this research is that it relies on publicly available data and agency theory. Future research could apply other theories, such as resource dependency and stewardship. Use of process-oriented data could also improve the findings. Practical implications – Independent directors need to undergo training to help them improve and be aware of their responsibilities. Originality/value – This paper offers evidence on the extent to which distress is associated with corporate governance from a developing country. The paper should be of interest to the regulatory bodies and practitioners. Keywords Boards of Directors, Chief executives, Corporate ownership, Financial performance, Corporate governance, Malaysia Paper type Research paper Introduction In recent years, criticisms have been targeted at corporate governance especially calling for reforms of the board of directors (Geneen, 1984; Kesner et al., 1986, Lorsch, 1989; Levitt, 1998). The argument is that the board of directors has not discharged its fiduciary roles effectively. In Asia, in the aftermath of the 1997 financial crisis, most Asian countries have sought to strengthen the corporate governance, transparency and disclosure levels (Ho and Wong, 2001). This paper seeks to examine whether board structure and ownership structure are associated with financial distress in Malaysia. The primary contribution of this study is the setting in which it is conducted, in which it examines the role of corporate governance on financial distress status within an emerging economy. Unlike the previous studies, which were done in North America or the UK, in this emerging economy, it is predicted that the market for corporate control is weak (Mak and Li, 2001). Significant efforts to improve corporate governance in Malaysia were only seen during the 1997-1998 crisis with the publication of the Report on Corporate Governance in 1999. Furthermore, concentrated shareholdings by individuals and families together with significant equity holdings by the PAGE 582 j CORPORATE GOVERNANCE j VOL. 6 NO. 5 2006, pp. 582-594, Q Emerald Group Publishing Limited, ISSN 1472-0701 DOI 10.1108/14720700610706072
2. Downloaded by Universiti Utara Malaysia At 20 :52 27 April 2016 (PT) government are two features that distinguish the ownership patterns of Malaysian companies from companies in the USA or in the UK, which could add complication to the corporate governance. This ownership pattern presents corporate governance issues, particularly ones that involve minority shareholders, that may not be similar to the ones peculiar to companies in those developed countries. In addition, the fact that Chinese and Malays dominate the economics and politics in Malaysia respectively provides a unique research setting that is not found elsewhere. The separation results in the regulators being predominantly Malays and the businesses being owned by the Chinese. Therefore, findings from this study should add to the understanding of institutional differences, which directly affect the operations of the boards of directors. Shleifer and Vishny (1997, p. 740) state that ‘‘Most of the available empirical evidence [on corporate governance] . . . comes from the United States . . . Unfortunately, except for the countries just mentioned, there has been extremely little research done on corporate governance around the world . . .’’ Another contribution is that the definition of financial distress adopted by this study is different than the one used in previous studies (e.g. Elloumi and Gueyie, 2001) where this study adopts the definition of financial distress as used by the Bursa Malaysia. Companies facing financial distress are expected to face a number of corporate governance issues, particularly on the issue of directors’ effectiveness in discharging their monitoring roles. This paper proceeds as follows. In the next section, the theoretical development will be covered, followed by the methodology section. The empirical results will be presented in the subsequent section, followed by the discussion section. Finally, the summary and conclusion section will follow. Theoretical development Financial distress and corporate governance Shareholders expect firms to adopt high-risk high-return strategies to maximize the value of the firms. Projects with positive NPVs and with high variance are therefore preferred. These strategies, however, could adversely affect a manager’s employment in the firm as it could face risk of failure. Managers, unlike shareholders who could diversify their portfolios, have their wealth tied to the firm’s survival. Instead, managers, seen as risk averse, may engage in activities that reduce the firm’s risk (Jensen and Meckling, 1976; Amihud and Lev, 1981) through, among others, corporate diversification (Amihud and Lev, 1981). This was actually observed among Malaysian companies in the early and mid-1990s when the Malaysian economy experienced a high economic growth with anual GDP growth of 7-8 percent. During this period, companies were seen to pursue the growth strategies by diversifying their businesses without proper cost-and-benefit analysis, which were made possible through easy access to bank loans (Abu-Bakar, 2001). In fact, Mohd-Nasir and Abdullah (2004) reveal that the gearing ratio of the distressed sub-sample was 12 times higher than the gearing ratio of the non-distressed firms. In 1998, a double-digit interest rate was observed and the Malaysian currency depreciated very significantly against major currencies. These situations had caused companies with high debts, which had been obtained in the mid 1990s, not being able to serve the debts, resulting in a total of 276 Bursa Malaysia listed companies having their non-performing loans taken over by the National Asset Management. It could be argued that had the boards been effective, companies would not have borrowed excessively and thus the risk of financial distress could have been avoided. The composition of a board of directors and leadership structure serve as a firm’s internal monitoring mechanisms in a corporate governance process (Walsh and Seward, 1990). In fact, Mizruchi (1983, pp. 432-3) claims that the board of directors is ‘‘the ultimate center of control’’ of a corporation. Further, being the highest decision-making body in a corporation, the board is accountable for the long-term health and survival of the corporation (Louden, 1982). The association between corporate governance structure and financial distress exists because financial distress is not a discrete event, rather it is a late stage of a ‘‘protracted process of decline’’ and a ‘‘downward spiral’’ (Hambrick and D’Aveni, 1988, p. 1). In fact, Daily and j j VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 583
3. Dalton (1994b) show that in the year of bankruptcy filing, financial indicators alone (profitability, liquidity and leverage) explain 95.54 percent of their bankruptcy model. Thus, a stronger board, compared to a weaker board, should be able to devise appropriate strategies to correct the downward trends faced by the firm. Staw et al. (1981) further explain that in declining or crisis periods, firms often resort to a ‘‘mechanistic shift’’ with centralization of authority being the result. Among the dysfunctional aspects of the shift include conservatism, rigidity, questionable escalation, reliance on past policies, increases in centralization and formalization and resistance to change (Staw et al., 1981; Singh, 1986; Cameron et al., 1987; Dutton and Duncan, 1987; Whetten, 1987). Argenti (1986a, b) suggests that corporate failures are associated directly with CEOs, boards of directors and top management members. It is therefore less likely that top management team members and inside directors, who work for the CEO, are able to oversee and control the CEO in times of crisis (Daily and Dalton, 1994a). In fact, studies have had doubts on the boards’ ineffectiveness in preventing bankruptcy (Gilson, 1990; Hambrick and D’Aveni, 1992; Gales and Kesner, 1994; Daily and Dalton, 1994a, b; Daily, 1995, 1996). It has been documented also that bankrupt firms lose prestigious top management team members immediately prior to a bankruptcy filing (D’Aveni, 1990). Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Another perspective that explains the role of corporate governance on financial distress is resource dependency (Selznick, 1949; Pfeffer and Salancik, 1978; Burt, 1983) that sees outside directors as a critical link to the external environment. Appointing representatives from significant outside constituencies as outside directors is viewed as ‘‘. . . a strategy for managing organizations’ environmental relationships’’ (Daily and Dalton, 1994b). Thus, these outside directors are expected to play active roles in ensuring firms not to enter into financial difficulty. Board structure Research on corporate governance has predominantly relied on agency theory (Daily et al., 2003). They, however, conclude that evidence of superior shareholders’ value from the shareholder-oriented perspective is not conclusive. In the literature, it has been shown that the board effectiveness in protecting the shareholders is associated with independence (e.g. Baysinger and Butler, 1985; Kosnik, 1987; Hermalin and Weisbach, 1988; Weisbach, 1988; Kini et al., 1995). Having outside directors is vital as they can act as ‘‘. . . providers of relevant complementary knowledge’’ to the management (Fama and Jensen, 1983, p. 315). However, evidence of non-executive directors ineffectiveness or even their adverse impacts on the board’s monitoring incentives has also been documented with the main concern on the issue of non-executive directors, who are not be truly independent of management (Vicknair et al., 1993; Bhagat and Black, 1997). In a similar vein, Perry (1995) contends that independent non-executive directors may adversely impact the board cohesiveness because they simultaneously play the roles of decision makers and monitors of management, which could lead to a conflict of interest. An effective board of directors should have led and monitored companies appropriately and designed the risk management mechanisms to ensure the companies are not exposed to excessive financial risks that could lead to it becoming financially distressed. Three characteristics, as argued by Jensen (1993), affect the monitoring potential of a board: board size, board composition and board leadership structure. Empirical evidence generally shows a link between board independence and distressed firms (Daily and Dalton, 1994b; Daily, 1995). In a study involving distressed Canadian companies, Elloumi and Gueyie (2001) show that the percentage of outside directors on the board of directors of distressed firms are significantly lower than that of the matched healthy firms and board independence negatively influences the firm’s financial healthiness. Chaganti et al. (1985), on the other hand, show that the extent of outside directors between failed and non-failed companies is not significantly different. Though research evidence is mixed, it is predicted j j PAGE 584 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006
4. that board independence is associated negatively with financial distress as the theory suggests . It is proposed that: H1. Board independence is negatively associated with financial distressed status. Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Research has shown that the discriminatory power for bankrupt/survivor firms go as far back as five years prior to the bankruptcy filing (e.g., Aziz et al., 1988; Baldwin and Glezen, 1992; D’Aveni, 1990; D’Aveni and MacMillan, 1990; Hambrick and D’Aveni, 1992). Thus, in times of declining performance, the boards that separate the roles of CEO and chairman are expected to be able to correct the ‘‘downward spiral’’ more effectively than the boards that combine the top two roles. A CEO who also serves as the board chairman is more likely to ‘‘. . . use their influence not to effect change, but to keep the course’’ (Daily and Dalton, 1994b, p. 1605). Evidence by Hambrick and D’Aveni (1992) supports this contention where they reveal that dominant CEOs are more likely to be related to bankrupt firms. Nevertheless, the substantial costs of the separation could come from ‘‘. . . the incomplete transfer of company information, and confusion over who is in charge of running the company’’ (Goodwin and Seow, 2000, p. 43). Hence, it could also be argued that when one person is in charge of both tasks, the decisions can be made much faster, especially during the time of crisis. Findings on the link between CEO duality and corporate failures, nevertheless, are mixed. Consistent with Hambrick and D’Aveni (1992), Daily and Dalton (1994b) find that firms with the CEO acting as the board chairman are more likely to go bankrupt as opposed to firms that are not. This evidence is reconfirmed by Elloumi and Gueyie (2001), who examine firms that are facing financial difficulties but contradicts Chaganti et al.’s (1985) evidence. However, in Malaysia, the issue of CEO duality is addressed in details in the Malaysian Code and thus the issue is seen to be important. Accordingly: H2. There is a negative association between CEO duality structure and financial distressed companies. Ownership structure The distinctive feature of Malaysian companies is the tightness of ownership where shares are held either by states, families or individuals (Abu-Bakar, 2001). Abdullah and Mohd-Nasir (2004) show that the average shareholdings by the top 20 shareholders are found to be at 73 percent. Any single largest shareholder has been found to hold, on average, 36 percent of the firm’s shares (Abdullah, 2001). Agency theory argues that shareholdings by management would reduce agency costs (Jensen and Meckling, 1976). Thus, this would reduce the likelihood of their firms becoming distressed. Nonetheless, excessive management shareholdings could lead to management entrenchment. Fama and Jensen (1983) postulate that firms that are controlled by management are less likely to survive in competition. The findings by Morck et al. (1988) and McConnell and Servaes (1990) reveal a curvilinear relationship between management interest and a firm’s value and support this contention. For Malaysian companies, anecdotal evidence by Abu-Bakar (2001) seems to suggest that the relation between management interest and distress is negative, supporting McConnell and Servaes’ (1990) evidence. According to McConnell and Servaes (1990), within a range of 5-25 percent for management interest, the association between management interest and firm’s value is positive. Thus, management interest is predicted to be negatively associated with financial distress. The hypothesis is as follows: H3. Management interests are negatively associated with financial distress. The extent to which non-executive directors hold shares in the firms is associated with their intensity in monitoring management and in ensuring management pursues value-increasing activities (Beatty and Zajac, 1994). It is argued that non-executive directors’ incentives lead to greater board’s monitoring management or involvement in strategy development and implementation (Kesner, 1987; Oswald and Jahera, 1991; Shivdasani and Yermack, 1999). j j VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 585
5. Hambrick and Jackson (2000) further show that the extent of non-executive directors interests not only help to create incentives but also make them more associated with the company, resulting in them being more involved in their oversight and more generous in their time and attention. Jensen and Meckling (1976) argue that substantial shareholdings by outside directors should provide greater incentives for them to monitor top management. Further, Jensen (1993, p. 864) contends that ‘‘encouraging outside board members to hold substantial equity interests would provide better incentive’’ to monitor the management. Thus, it is predicted that the interests of non-executive directors are negatively associated with financial distress. The hypothesis is therefore as follows: H4. Non-executive directors’ interests are negatively associated with financial distress. Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Large shareholders could limit agency problems (Shleifer and Vishny, 1986; Admati et al., 1994; Noe, 2002). Kang and Shivdasani (1995) also show that the large shareholders lead to an increased management turnover. Thus, interests by outsiders are predicted to play important roles in determining the financial distressed status, more importantly those who own a large percentage of shares. Furthermore, these outside blockholders have their wealth tied to the financial performance of the firms, and are therefore predicted to invest their money in companies that are financially healthy. The hypothesis is thus as follows: H5. The extent of outside blockholder’s interests is negatively associated with financial distressed companies. Methodology In this study, financial distressed companies are defined as those that are classified in the Bursa Malaysia PN4 sector. Following the 1997 crisis, the Bursa Malaysia issued the Practice Note 4 in 2001, which outlines the criteria used by the Bursa Malaysia to identify companies that are required to regularize their financial conditions. Failure to regularize their financial conditions within the stipulated time results the company being de-listed. The deadline given to these companies was 31 December, 2002. Four criteria have been outlined by the Bursa Malaysia, and the fulfillment of at least one criteria results in the company being referred as ‘‘an affected listed issuer’’: 1. deficit in the adjusted shareholders’ equity; 2. appointment of receivers and/or managers over the property of the listed issuers; 3. adverse opinions or disclaimers in respect of the going concern form the auditor; or 4. appointment of special administrators pursuant to the provisions of the Pengurusan Danaharta Nasional Berhad Act 1998. The Bursa Malaysia implemented PN4 classification in 2002. The decision on categorizing a firm into PN4 is made by Bursa Malaysia if the listed firm fulfills one of the above criteria. Trading of shares of these affected companies is either suspended or restricted. Vanhorne (1971) describes two situations of corporate failure: technical insolvency and insolvency in bankruptcy. A company is said to face technical insolvency when it is unable to meet its current obligations and insolvency in bankruptcy occurs when a company’s net worth is negative. Thus, based on the definition, Bursa Malaysia PN4 companies fall under insolvency in bankruptcy. According to Wruck (1990), a company enters into financial distress following economic distress, decline of performance or poor management. As at 31 December, 2002, a total of 86 companies were classified under the Bursa Malaysia PN4 sector, after excluding finance companies. A matched company for each PN4 company was determined on three bases: Bursa Malaysia sectorial classification, similar total assets and positive EPS throughout the period of study. The financial years that this study was interested in were the periods prior to the PN4 classification introduced by the Bursa Malaysia but after the crisis, i.e. 1999-2001. j j PAGE 586 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006
6. To test the hypotheses , the pooled logistic regression analysis was carried out, which is as follows: STATUSit ¼ a þ b1 YR1 þ b2 YR2 þ b3 BDINDit þ b4 DUALITYit þ b5 MGTit þ b6 NEDit þ b7 OUTBLKit þ b8 ACINDit þ 1it : where: i: firm 1 through 86; t: year 1999 through 2001; STATUS: ‘‘1’’ if distress, ‘‘0’’ otherwise; YR1: ‘‘1’’ if financial year 1999, ‘‘0’’ otherwise; YR2: ‘‘1’’ if financial year 2000, ‘‘0’’ otherwise; BDIND: percentage of independent directors on the board; DUALITY: ‘‘1’’ if the board chairman and CEO roles are combined, ‘‘0’’ otherwise; MOWN: percentage of shares held by executive directors; Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) NEDOWN: percentage of shares held by non-executive directors; OUTBLK: cumulative percentage of shares outside shareholders holding 5 percent or more of shares; and ACIND: ‘‘1’’ if all audit committee members are independent directors; ‘‘0’’ otherwise. Audit committee independence is included in the regression model as one of the control variables. Carcello and Neal (2000) examine financially distressed companies and they find a negative relation between the extent of inside or affiliated directors on the audit committee and the likelihood of that firm being given a ‘‘new’’ going-concern report. In another paper, Carcello and Neal (2003) show a direct association between the proportion of inside and affiliated directors on the audit committee and the likelihood of a firm changing external auditors after being given a going-concern report. In the present study, audit committee independence is treated as a dummy variable with value ‘‘1’’ being given if all the members are independent directors. This is motivated by the Sarbanes-Oxley Act of 2002 (Section 301) (US Congress, 2002), which requires firms to maintain audit committees whose members are all independent. Results Out of 86 non-finance companies that were in the Bursa Malaysia PN4 sector as at 31 December, 2002, four companies were excluded due to change in financial year ends and data unavailability. As a result, a total of 504 firm years were available for the pooled analysis (1999: 170, 2000: 170, 2001: 164). Results of the descriptive statistics and the t-tests are shown in Table I. Results in Table I support all the selection criteria used in choosing the matched companies. Results in Table I also show that distressed firms have a lower liquidity ratio as opposed to non-distressed firms and the latter’s liquidity ratio is five times higher than the former’s. Thus, the gearing and liquidity ratios are associated with distressed firms, supporting the evidence among bankrupt and non-bankrupt companies (e.g. Altman, 1968; Platt and Platt, 2002). The earnings per share (EPS) of the distressed sub-sample is significantly negative compared to the EPS of non-distressed firms, which is significantly positive. An analysis also indicates that the EPS of distressed sub-sample has been negative since the 1998 financial year (1998: 2RM1.54, 1999: 2RM1.4, 2000: 2RM0.82, 2001: 2 RM0.76). This evidence thus suggests that these firms have started to experience financial difficulty immediately after the 1997 crisis. Table II shows the results from the pooled logistic regression analysis. Results in Table II show that the influence of years (i.e. 1999, 2000 and 2001) is not significant. As for hypothesis testing, results in Table III suggest that H1 is not supported. In Model 2 of Table II, j j VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 587
7. Table I T-test results (distressed ¼ 252 firm years, healthy ¼ 252 firm years) Variables Earnings per share (in cents) Distressed Healthy All firms Total assets (’000) Distressed Healthy All firms 20.99 0.26 20.35 480,115 678,909 579,512 Std dev. 1.66 0.27 1.34 1,510,343 1,203,658 1,367,902 T-value ( p-value) 211.94 (0.000)a 21.634 (0.103) Board independence (BDIND) Distressed Healthy All firms 0.45 0.39 0.42 0.18 0.13 0.16 CEO duality (DUAL) Distressed Healthy All firms 0.11 0.15 0.13 0.32 0.36 0.34 21.195 (0.232) 16.65 28.83 22.74 19.60 21.61 21.49 26.623 (0.000)a 2.53 6.71 4.62 6.39 11.78 9.69 24.953 (0.000)a 16.12 20.73 18.43 18.37 24.52 21.77 22.393 (0.017)b Audit committee independence (ACIND) Distressed Healthy All firms 0.13 0.15 0.14 0.33 0.36 0.35 20.772 (0.441) Liquidity (LIQDTY) Distressed Healthy All firms 0.48 2.36 1.42 0.47 1.92 1.68 215.041 (0.000)a Gearing (GRG) Distressed Healthy All firms 1.87 0.18 1.03 5.01 0.22 3.65 5.425 (0.000)a Executive directors’ interest (MGMT) Distressed Healthy All firms Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Mean Non-executive directors’ interest (NED) Distressed Healthy All firms Outside blockholding (OUTBLK) Distressed Healthy All firms 4.404 (0.000)a Notes: a/b statistically significant at less than 1%/5% levels respectively, two-sided tests board independence was operationalized by combining independent directors and non-independent non-executive directors, which were divided by the board size, the finding of which shows that board independence remained insignificant. Results with respect to CEO duality are mixed. In Models 1, 2 and 3 where CEO duality is defined as the CEO-cum-board chairman, the relation is found to be negative but it is not significant. Thus, H2 is not supported. However, in Model 4, when CEO duality is defined as executive chairman, the influence becomes negative, as predicted and significant. Thus, H2 is supported. Model 3 tests also whether the effects of management ownership on financial distressed status is curvilinear by including MOWN2 in Model 3. Results suggest that the relation of management interests with financial distressed status is not linear. At the lower levels, interests by management lead to an alignment of interests. At the higher levels, the evidence j j PAGE 588 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006
8. Table II Logistic regression analyses (N ¼ 504) Variables Intercept YR1 YR2 BDIND NEDBOARD DUAL CHREXEC ACIND MOWN1 MOWN2 NEDOWN OUTBLK Predicted signs Model 1 (Wald) Model 2 (Wald) Model 3 (Wald) Model 4 (Wald) ? ? ? – – þ þ – – þ – – 2.426 (24.867)a 0.160 (0.383) 0.127 (0.240) 0.832 (1.321) – 20.445 (1.792)b – 20.754 (4.589)b 20.063 (76.42)a – 20.107 (50.229)a 20.046 (52.491)a 2.556 (24.607)a 0.172 (0.439) 0.133 (0.263) – 0.420 (0.650) 20.417 (1.541) – 20.702 (4.116)b 20.064 (83.31)a – 20.114 (51.29)a 20.048 (54.94)a 3.052 (30.59)a 0.200 (0.586) 0.142 (0.298) 0.697 (0.896) – 20.431 (1.641) – 20.752 (4.450)b 20.117 (34.86)a 0.001 (9.534)a 20.118 (52.29)a 20.032 (10.546)a 2.180 (18.94)a 0.143 (0.306) 0.126 (0.234) 0.917 (1.597) – – 0.436 (3.631)b 20.697 (3.920)b 20.064 (78.59)a – 20.101 (44.96)a 20.044 (48.43)a 0.359 158.18a 73.6% 0.358 157.04a 72.4% 0.377 167.5a 74.4% 0.363 160.04a 77.0% Model summary: Nagelkerke-R2 Chi-square 158.18* Classification performance Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Notes: NEDBOARD: percentage of non-executive directors on the board; CHREXEC: a dummy variable, ‘‘1’’ if executive chairman, ‘‘0’’ otherwise; astatistically significant at less than 0.01 level, one-sided tests; b statistically significant at less than 0.1 level, one-sided tests Table III Further logistic regression analyses (N ¼ 504) Variables Intercept YR1 YR2 BDIND BDSIZE CHREXEC ACIND MOWN INSDBLK NEDOWN NGOUTBLK GOVPCTG GOVLINK Model summary: Nagelkerke-R2 Chi-square Classification performance Predicted signs Model 1 (Wald) Model 2 (Wald) Model 3 (Wald) Model 4 (Wald) ? ? ? – ? þ – – – – – ? ? 2.129 (17.958)a 0.153 (0.343) 0.126 (0.233) 0.834 (1.283) – 0.442 (3.692)# 20.613 (2.832)# 20.061 (69.88)a – 20.099 (43.49)a 20.038 (29.47)a 20.063 (24.26)a – 2.111 (17.81)a 0.139 (0.285) 0.124 (0.227) 0.856 (1.347) – 0.408 (3.148)# 20.591 (2.633)# 2 20.062 (70.56)a 20.099 (43.69)a 20.038 (29.47)a 20.063 (24.16)a – 1.402 (9.43)a 0.104 (0.172) 0.119 (0.224) 1.307 (3.428)# – 0.471 (4.475)# 20.798 (5.524)* 2 20.055 (65.196)a 20.087 (37.096)a 20.033 (24.99)a – 21.020 (3.960)b 5.416 (48.976)a 0.197 (0.504) 0.111 (0.160) 20.566 (0.483) 20.435 (37.948)a 0.345 (1.947)# 20.137 (0.124) 2 20.054 (51.583)a 20.084 (30.988)a 20.035 (22.26)a 20.053 (16.92)* – 0.369 163.55a 75.6% 0.372 164.63a 76.0% 0.311 134.06a 73.6% 0.454 209.63a 76.0% Notes: NGOUTBLK: percentage of shares held by outside blockholders not related to government; GOVPCTG: percentage of shares held by government; GOVLINK: a dummy variable, ‘‘1’’ if government holds 5% or more shares and ‘‘0’’ otherwise; astatistically significant at less than 0.01 level, one-sided tests; bstatistically significant at less than 0.1 level, one-sided tests supports the management entrenchment theory. This is generally consistent with Morck et al. (1988) and Short and Keasy (1999). Findings in Table II, for all models, provide support for H3, H4 and H5. Table III presents results from additional analyses to test further the influence of ownership and board size. In Model 1, outside blockholders are broken down into two: percentage of government-linked outside blockholdings and percentage of non-government related outside blockholdings. Government-linked entities are government-linked institutional investors (both the Federal and the State-linked funds and companies) and government-supervised funds. Findings of Model 1 indicate that H1 is not supported, while H2, H3, H4 and H5 are supported. Model 2 in Table III tests the association of inside blockholders on financial distressed status. Results are similar to those found earlier. In Model 3 of Table III, the percentage of government-linked outside blockholders was treated j j VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 589
9. as a dummy variable . Results show that both non-government outside blockholders and government-linked variables are not significant in determining the firm status. Downloaded by Universiti Utara Malaysia At 20:52 27 April 2016 (PT) Finally, in Model 4, a variable board size is included. Jensen (1993) and Lipton and Lorsch (1992) argue that large board boards are not effective compared to smaller boards. Yermack (1996) provides empirical evidence supporting this contention. Nonetheless, having more directors on a board could enable the firm to utilize the expertise and services of the directors particularly when the additional directors are outsiders as argued by the resource dependency theory (Tricker, 1984, p. 171) and could serve as the window to the outside world and are better able to form environment link (Goodstein et al., 1994). Thus, larger board sizes should lead to lower probability of a firm to become distressed. Findings by Chaganti et al. (1985) show that non-failed firms have larger boards than failed firms. However, an oversized board size could lead to the problem of coordination (Forbes and Milliken, 1999), which potentially leads to the board becoming less involved in strategic decision making (Judge and Zeithaml, 1992). Thus, Jensen (1993) argues that the maximum size of a board is seven or eight. Based on the extant evidence, Hermalin and Weisbach (2003, p. 13) conclude that ‘‘The data therefore appear to reveal a fairly clear picture: board size and firm value are negatively correlated.’’ Nevertheless, neither too small a board nor too large a board may be effective. Rather increasing the size the board up to the optimum number (7-8 as argued by Jensen (1993)) should lead to effective monitoring. While increasing the size once it has reached the optimum size should result in the board becoming ineffective. The Malaysian boards were found to have about eight directors (Abdullah, 2001). Thus, it is predicted that there is a negative association between board size and the distressed status. Results in Model 4 of Table III are as predicted and consistent with Jensen’s (1993) argument and the findings by Chaganti et al. (1985). Further, the board size in Malaysia in the present study is about seven, which is similar Mak and Li’s (2001) findings that found Singaporean board size being eight. Conclusions Findings of the present study do not support the contention that board independence is significant in explaining a firm’s distressed status. This evidence contradicts that of Elloumi and Gueyie (2001) but consistent with the findings by Chaganti et al. (1985). The passive roles of independent directors could be attributed to the nature of their appointments and their conflict of roles (Vicknair et al., 1993; Perry, 1995; Bhagat and Black, 1997). An analysis was carried out to determine if the composition of the board had been changed during the period 1999-2001. The percentages of independent directors for both distressed and non-distressed sub-samples changed marginally during the period, suggesting some board restructuring in 2001, the year prior to the implementation of PN4 classification in 2002. Independent directors may not be aware of their responsibilities. Thus, requiring them to undergo training may help them to improve their monitoring skills. Future research, perhaps, as argued by Daily et al. (2003), could apply such theories as resource dependence and stewardship as well collecting process-oriented data that could offer alternative explanation of the board’s roles. Evidence of the roles of CEO duality in determining the firm’s financial distress is mixed. This evidence is consistent with previous studies in Malaysia (Abdullah, 2004; Abdullah and Mohd-Nasir, 2004) and in Canada (Elloumi and Gueyie, 2001). The insignificance of CEO duality could perhaps be due to the lack of consensus on the recommendation for the separation, as argued by Elloumi and Gueyie (2001). In fact, the existing corporate governance codes, e.g. the Cadbury Code, 1992 (Cadbury Committee, 1992); the Hampel Report (1998); the Malaysian Code on Corporate Governance (Finance Committee on Corporate Governance, 2001), do not prohibit the practice of combining the board chairman and CEO roles, provided that companies disclosed in the annual reports the reason for the departure. Furthermore, previous literature and evidence on the significance of CEO duality are mixed (Berg and Smith, 1978; Chaganti et al., 1985; Daily and Dalton, 1994a) and some even have questions on the benefits from the separation (Goodwin and Seow, 2000). Combining the top two roles enable urgent strategic decisions to be made faster especially during declining performance. j j PAGE 590 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006
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