Enhancing firm value under concentrated ownership - Free Essay Example

Sample details Pages: 5 Words: 1394 Downloads: 6 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? Corporate boards of the company are primary drivers for growth and value maximization. Boards of directors as fiduciaries of the shareholders are delegated with the task of monitoring the management to protect the rights shareholders and enhance the value of their capital (Jensen and Meckling, 1976). The structure of board therefore plays an important role in determining the performance of board and maximizing shareholder wealth (Ghosh, 2006). The board is a vital internal corporate governance mechanism and effective in controlling the management and reducing the agency problem (in dispersed shareholding conditions) (Fama and Jensen, 1983). The introduction of non-executive directors on the board was aimed at solving the agency problem and enhancing board performance. The existing literature suggests that outside directors (particularly independent directors) are able to protect the shareholder interests and can perform value enhancement in case of agency problem (Fama and Jensen, 1983; Fraser and Zhang, 1995; Linck et al. 2008). However, under concentrated ownership conditions, generally, the owner is also manager and the issue of agency problem is minimal. Don’t waste time! Our writers will create an original "Enhancing firm value under concentrated ownership" essay for you Create order The board composition with majority of outside directors under concentrated ownership therefore becomes a critical question. The issue arises whether the outside directors: independent and grey (non-executive non-independent); can play critical role and perform value enhancement through their knowledge and expertise. The majority owners under concentrated ownership as regard to their voting rights have control on selection process of directors and therefore directly influence appointments to the board. This matter assumes importance in determining the quality of independent and grey directors and their ability to protect, particularly the minority, shareholder interests. Predominant literature on corporate governance related to effect of board size on firm performance predicts a negative relationship (Yermack, 1996; Gosh, 2006; Guest, 2009). The negative influence of larger group dynamics in bigger board prevail over the anticipated potential advantages of greater number of people on such board (Jensen, 1993). The current study aims to extend research done by Ghosh (2006) on board structure on firm performance in Indian context. In particular, study aims at investigating the effect of board size and composition of board, that is, percentage of inside, independent and grey directors on the board performance. The research is new the perspective, as it aims to understand how presence of these directors on the board affects firm value in period of financial distress under concentrated ownership. II. Research Design The sample used in this study consists of 164 non- financial firms of Bombay Stock Exchange (BSE) 200 index of India for the financial year 2008-2009. The data on board size and composition was taken from corporate governance report of the companies. The other financial and market data was obtained from Prowess database of Centre for Monitoring Indian Economy (CMIE). Tobin Q = ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²0 + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²1 LBsize + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²2 Fage + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²3 Fsize + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²4 Lev + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²5 Roa + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²6 Ownblock3 + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²7 Indusdum + e ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦eq1 Tobin Q = ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²0 + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²1 LBsize + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²2 (Direc: EXE or GR or IND) + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²3 Fage + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²4 Fsize + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²5 Lev + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²6 Roa + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²7 Ownblock3 + ÃÆ'Ã… ½Ãƒâ€šÃ‚ ²8 Indusdum + e ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦eq2 The effect of board size on firm performance is estimated through equation 1, while equation 2 is used for analyzing effect of different categories of directors on the firm performance. The market based performance measure Tobins Q has been used a dependent variable to analyse the effects. Several control variables have been included in model to remove the problem of endogenity and to account for the potential advantages of economies of scale, growth, scope of market power and risk characteristics of firms (Hermalin and Weisbach, 1991; Vafeas and Theodorou, 1998; Shanmugam and Bhaduri, 2002) Table 1 Description of the Variables Type Variable Description and measure Dependent TobinQ Tobins Q , market value of equity plus book value of short-term and long-term debt divided by total assets Independent LBsize Board Size, natural logarithm of the number of director on the board PerEX Executive Directors, percentage of executive directors on the board PerGR Grey Directors, percentage of grey directors on the board PerIND Independent Directors, percentage of Independent directors on the board Control Fage Firm Age, the logarithm of the number of years since the establishment of a firm Fsize Firm Size, natural logarithm of total assets Lev Firm leverage, ratio of long term debt to the total assets Roa Return on assets, measured net profit to the total asset Ownblock3 Ownership block holding, measured percentage ownership of top three block holders of the company indusdum Industry dummy, Industries shown in table III given dummy values from 1 to 15 Table 2 Descriptive Statistics of Variables Variables TobinQ LBsize PerEXE PerGR PerIND Fage Fsize Lev Roa Ownblock3 N 164 164 164 164 164 164 164 164 164 164 Mean 1.504 2.345 29.269 20.291 50.440 7.587 8.815 23.567 0.774 79.056 Median 1.095 2.303 30.000 18.182 50.000 7.591 8.611 23.975 0.550 80.277 Std. Dev 1.359 0.292 12.948 14.421 10.574 0.012 1.131 19.164 0.663 11.865 Minm 0.000 1.609 0.000 0.000 20.000 7.539 6.672 0.000 0.010 46.732 Maxm 8.650 2.996 55.556 62.500 85.710 7.604 12.413 67.960 3.530 100.000 III. Results and Discussion The Indian corporate governance code i.e. Clause 49 of the Listing Agreement which necessitates half of board to be comprised of independent director in case executive or non executive promoter or relative being the Chairman. The results point that on an average, the boards of companies have 70 percent non-executive directors (outside directors) and 50 percent of independent directors. Further analysis ( table III) suggest that companies having larger board size ( more than 11) find it difficult to have 50 percent independent directors on the board. Ghosh (2006) has analyzed the effect of the board composition on firm performance and, finds weak positive association of outside directors with firm performance. Extending his work and also controlling for board size , we have analyzed the effect of three categories of directors namely; inside, independent and grey directors on the firm performance. The regressions results (table IV) reveal that under concentrated ownership regime in per iod of financial distress (08-09), greater proportion of inside directors on the board significantly affects firm performance, whereas greater percentage of grey directors significantly deteriorates the firm performance. Higher percentage of independent directors on board has no significant affect on the firm performance. Consistent with study of Ghosh (2006) and other international studies and, we find that board size is negatively associated with Tobins Q, though not at any significant level. We see that average board size of sample companies is approx 11 (table III). The result suggests that larger boards are ineffective in monitoring the management due to higher agency cost associated with it, and ideal board size for Indian companies should smaller and below 11. Table 3 Board Composition Industry Companies Board Size Exe Direc Grey Direc Ind. Direc NE Direc ( Grey+ Ind)    ( Number) (Avg Size ) ( Avg Percen) ( Avg Percen) ( Avg Percen) (Avg Percen) Agriculture 7 10.71 34.27 16.67 49.06 65.73 Capital Goods 14 11 30.25 18.95 50.79 69.75 Chemical 3 13 33.9 14.58 51.52 66.1 FMCG 9 10.11 26.6 23.05 50.35 73.4 Healthcare 15 9.73 34.62 12.02 53.35 65.37 Housing Related 18 11.38 29.97 19.74 50.29 70.03 Information Technology 12 9.83 25.23 18.64 56.13 74.77 Metals and Mining 18 11.11 30.44 21.58 47.97 69.56 Oil Gas 16 11.56 33.78 22.73 43.48 66.22 Power 13 12.15 26.31 22.88 50.8 73.69 Telecom 6 9.33 13.89 33.89 52.22 86.11 Automobiles 12 11.58 29.13 22.14 48.72 70.87 Transport Services 6 10.83 32.38 16.94 50.67 67.61 Textile 4 9.75 22.32 24.46 53.21 77.68 Others 11 10.27 24.68 21.45 53.86 75.31 Total 164 10.89 29.26 20.29 50.44 70.73 Table 4 TobinQ- Model Board performance Dep Variable Model 1 Model 2 Model 3 Model 4 Ind variables coeff t coeff t coeff t coeff t (Constant) 0.217 3.331** 0.182 2.674** 0.247 3.757* 0.183 2.449*** LBsize -0.171 -1.542 -0.186 -1.686+ -0.147 -1.333 -0.146 -1.284 PerEX       0.077 1.682+             PerGR             -0.101 -2.195***       PerIND                   0.08 0.917 Control Variables                         Fage -9.276 -1.396 -8.546 -1.291 -9.3 -1.417 -0.9781 -1.467 Fsize -0.408 -3.259** -0.429 -3.428** 0.451 -3.6* -0.419 -3.329** Lev -0.089 -2.309*** -0.098 -2.536*** -0.104 -2.685** -0.092 -2.365*** Roa 0.297 5.276* 0.287 5.102* 0.287 5.155* 0.298 5.293* Ownblock3 0.331 3.558* 0.315 3.387** 0.338 3.67* 0.346 3.66* indusdum -0.002 -0.576 -0.001 -0.214 0 -0.142 -0.002 -0.566 No. of Firms 164 164 164 164 indusdum Included Included Included Included R 0.578 0.588 0.595 0.581 R square 0.334 0.346 0.354 0.338 Adj R square 0.304 0.312 0.321 0.303 F change 11.173* 10.245* 10.618* 9.872* * denotes significance at 0.01 % level ,** denotes significance at 1 % level, *** denotes significance at 5% level , + denotes significance at 10 % level IV. Conclusion The current study investigates which directors are able to enhance performance of corporate boards of companies in Indian context. The results suggest it is particularly the inside directors who are committed to shareholders for their wealth maximization. The inside directors know the company well, have full time commitment and own significant proportion in the company. There interests are much aligned with company, to they can perform value maximization role. Outside directors play a limited role under concentrated ownership regime as evident by regression results. Their quality and ability to protect minority shareholders has also become questionable after Satyam fiasco (Singh and Kumar; 2010). Outside directors and particularly Grey directors are not able to play their role of value maximization in absence of agency problem. Thee study has few implication and lends support for Indian policy makers who aiming to propose the new corporate governance framework for companies through the Companies Bill, 2009. The new legislation proposes to limit to number of independent directors on the board to one third. Our study lends support to this proposed rule and suggests for improving the quality of outside directors. It also necessary to rationalize board size as larger board is ineffective enhancing the firm performance. Our study also lends support to requirement of this legislation that limits board size from three to 12. Based on our findings, we propose further reduce this to 10 or 11 (average board of sample companies) that certainly help in enhancing board performance.