Research ProposalDurayya Debaj Makhdoom

Does Corporate Governance beget Firm’s Performance:

An Empirical Study of Fortune -500 Companies

• This study aims at investigating whether corporate governance has an effect on Fortune 500 firms’ performance. The purpose of the research is to investigate the relationship between corporate governance practices and firms’ performance. There are eight variables to conduct the study, out of which five variables namely Board Size, Board Independence, Frequency of Board Meetings, Presence of Large Shareholders and CEO Compensation relate to Corporate Governance and three variables namely Return on Assets, Stock Return and Tobin’s Q relate to Firm Performance. Secondary resources will be used to collect the data. Multiple Regression Models will be used to analyze the collected data. This proposal gives a brief insight of our proposed study.

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1. ABSTRACT

• In recent times, corporate governance has started to take centre stage in private sector circles.

• The reason for this recent resurgence of corporate governance is the global economic crisis; a crisis which has been largely attributable to poor mortgage investment decisions amongst many financial institutions led to the near collapse of the global banking industry. (Erkens et al., 2012)

• Investigation has revealed that there seemed to be a failure of corporate governance within such institutions as management in such organizations made decisions considered as non-investor friendly.

• Poor corporate governance decisions were responsible for the collapse of Lehman Brothers; a financial disaster that almost brought Wall Street and the City to its knees (Erkens et al., 2012).

2. INTRODUCTION

• The role of corporate governance in enhancing the risk management strategies of many organizations cannot be under-stressed.

• In examining the relationship between corporate governance and increased organizational performance, this research will focus on CG variables responsible for financial performance of Fortune 500 companies. Overall, this research will establish the relationship between corporate governance and organizational performance.

2. INTRODUCTION

• Corporate governance has been part of research in business economics since Adam Smith’s (1776) seminal publication of An Inquiry into the Nature and Causes of the Wealth of Nations

But..• The 2008 financial crisis arose up new questions

regarding the role and vitality of corporate governance in all firms especially the big market giants. (Erkens et al., 2012)

• There is a need to study the relationship between use of stringent corporate governance and its impact on large firms’ performance.

3. STATEMENT OF PROBLEM

Whether industry leaders of today face a tradeoff between advanced firm performance and good corporate

governance, or the former variable is ensured by the use of later?

• The role of good governance rules in assisting financial results must be studied to envisage a comprehensive regulatory programme that must benefit rights of both the stakeholders and owners

3. STATEMENT OF PROBLEM

The objectives therefore are: o To investigate if firms continuously prevalent on

Fortune 500 list for last 10 years follow some specific corporate governance mechanisms.

o To investigate the impact of variation in corporate governance patterns on the firms’ performance on year on year basis. (within the firm)

o To investigate the relationship between corporate governance practices and firms’ performance of Fortune 500 companies.

4. RESEARCH QUESTIONS

• Shareholders aspire to get the best value for their investments. Any research that seeks to investigate the practices helpful for enhanced performance or growth is a significant contribution for shareholders.

• The study would quest for existence of a set of specific corporate governance patterns common amongst the industry outperformers. This may pave a new direction for developing a well-encompassing framework to guide about what kind of governance practices lead to better firm performance. Such framework would be helpful for the companies who are striving to be amongst the Fortune-500 market outperformers, or who wish to benchmark the corporate governance practices of Fortune -500 companies.

5. SIGNIFICANCE OF STUDY

Researcher Year RelationshipsStenberg 1998 CG and

Organizational Internal Controls

Solomon 2004, 2010 CG & Shareholders protection

Bhagat & Bolton 2008 CG & Firm Performance

Crane et. al 2008 CG & Corporate social Responsibility

Erkens et al. 2012 CG & Financial Crisis of 2008

6. Preliminary Literature Review

• There is very scarce literature available that deals with impact of corporate governance on the firm performance with sample of Fortune 500 companies. As such no study directly has explored the corporate governance patterns of Fortune 500 companies and compared these with the firms’ performance. The available research deals with same variables but have been conducted within different geographical context, or using different sample of firm sectors.

• This research is unique as it intends to investigate the impact of corporate governance on firm’s performance in the global market leaders, specifically targeting the population of all Fortune-500 companies, irrespective of their geographical location or operational sector. The results will be helpful in understanding the effectiveness of good governance for becoming a major market player.

7. RESEARCH GAP

8.1. Hypotheses H1: Board Size is inversely related to Firm PerformanceH2: Board Independence is positively related to Firm Performance.H3: Frequency of Board Meetings has an inverse relation with Firm Performance.H4: Presence of Large Shareholders is inversely related to Firm Performance.H5: CEO Compensation is negatively related to Firm Performance.

8. THEORATICAL FRAMEWORK AND

HYPOTHESES

Figure: Conceptual Framework

Corporate Governance  •Board Size•Board Independence•Frequency of Board Meetings•Number of Large Shareholders•CEO Compensation

Firm Performance  •ROA•Stock Return•Tobin’s Q

Firm SizeLeverage

(Control Variables)

8.2 Theoretical Framework

9. RESEARCH METHODOLOGY

• The proposed research is exploratory, correlational and quantitative in nature.

• First we will look into the existence of some specific set of corporate governance practices in Fortune 500 companies.

• Secondly we will determine the cause and effect relationship between these corporate governance practices and their impact on firms’ performance on yearly basis.

• Fortune 500 companies have been taken as the population of the study.

• We will collect the data of 10- year period i.e from year 2004 to year 2013. Therefore, a sample of 100 companies prevalent on Fortune 500 list for last 10 years will be randomly selected. This sampling is suggested to ensure complete range of data across the study period.

9.1 Population and Sample Description

• Data to make the analysis will be collected from secondary sources like Fortune 500 magazine, Reuters and firms’ official websites.

9.2 Data Collection Method and Procedure

Following the research work of Erkens et al (2012) and Bhagat S. & Bolton B. (2008), we will use following research variables.

Corporate Governance Variables:1.Board Size: Number of directors on the board.2. Board Independence: The number of unaffiliated independent directors divided by

the total number of board members. 3. Frequency of Board Meetings: Number of annual general meetings held in a year.4. Presence of Large Shareholders:5. CEO Compensation6. CEO Chair Duality (Dummy Variable) Equals one when the CEO is not the chairman of the board, and zero otherwise.

9.3 Data Coding and Analysis Techniques - Variables:

Firm Performance Variables:7. Return on Assets: ROA is measured as operating income divided by

end of year average total assets. In general, following Bhagat & Bolton (2008), we use operating income before depreciation

8. Stock Return: Capital Gain in Stock Price + Dividend / Original

Stock Price9. Tobin’s Q:(Market value of equity+ Book value of debt)/ Book

value of assets

9.3 Data Coding and Analysis Techniques - Variables:

Control Variables: In addition we control for firm size (assets), and

leverage (debt/total asset ratio) as suggested by Bhagat S. & Bolton B. (2008). Firm size and growth control for potential advantages of scale and scope, market power and market opportunities. The leverage controls for different risk characteristics of firm and industry.

9.3 Data Coding and Analysis Techniques - Variables:

• The study uses more than one proxy for accounting and market measure of firm performance.

9.3.2 Variables Measurement:

Return on Assets Operating Income/Avg. of Total Assets

Stock Return Capital Gain in Stock Price + Dividend

/ Original Stock Price

Tobin’s Q ( Market value of equity+ Book value of

debt)/ Book value of assets

Firm Size Natural log of total book value of assets

Leverage Total Debt/Total Assets

Multiple regression models are used to find out the association between corporate governance and firms’ performance in the context of Fortune 500 companies. Our base models take the following form:

Y it = ß0 + ßXit + µitWhere: Yit is the dependent variable.ß0 is the intercept. Xit is the independent variable.µit are the error terms. i is the number of firms and t is the number of time periods.

9.3.2.1. Research Models

• YROA =β0-β1SIZE + β2INDP - β3FQY - β4LGSH - β5CEOCOMP +β6 (dummy) CEODUAL+ µit

• YTQ = β0-β1SIZE + β2INDP - β3FQY - β4LGSH - β5CEOCOMP +β6 (dummy) CEODUAL+ µit

• YSKRTN = β0-β1SIZE + β2INDP - β3FQY - β4LGSH - β5CEOCOMP+β6 (dummy) CEODUAL+µit

9.3.2.1. Research Models

• We will apply Heteroscedasticity tests (Breusch-Pagan test, F-test) to control for the endogeneity among the variables.

9.3.2.2. Heteroscedasticity

Quantitative techniques will be employed. Descriptive statistics, correlation matrix and multi-regression models will be used for analysis of data.

9.3.2.3. Data Analysis

9.3.4. InstrumentationAs this research is based on secondary data collection, there is no instrumentation involved. The data will be collected and arranged using panel data approach.

• Better Governance reporting: A Practical Framework. Independent Audit Limited. Available at www.independentaudit.com/goodreporting

• Bhagat S. & Bolton B. (2008). Corporate Governance and Firm Performance. Journal of Corporate Finance. Vol (14). Pg. 257-273.

• Crane A., McWilliams A., Matten D., Moon J. & Siegel D. The Oxford Handbook of Corporate Social Responsibility. Oxford University Press. (2008). USA.

•  Erkens D.H., Hung M. and Matos P. (2012). Corporate governance in 2007 – 2008 financial crisis: Evidence from financial Institutions worldwide. Journal of Corporate Governance. Vol 18 (2012). Pg 389-41

10. References

 • Gompers A. P., Ishii L. J., & Matrick A. Corporate Governance and Equity Prices.

Quarterly Journal of Economics. (2003) • La Porta R. Lopez-De-Silanes F. Shleifer A. & Vishney R. (2000). Investor

Protection and Corporate Governance. Journal of Financial Economics. Volume 3-27. (2000).

 • Solomon J. & Solomon S. (2004). Corporate Governance and Accountability. Wiley

Publishers.  • Solomon J. (2010). Corporate Governance and Accountability. Wiley Puvlishers.

Ed. III. USA. • Sternberg E. (1998). Corporate Governance: Accountability in Market Place.

Institute of Economic Affairs 1998. UK.

References (Cont’d)