thesis rizki putri_926723
TRANSCRIPT
Interaction Effect of Corporate Governance Mechanisms
In Multinational State-Owned Enterprises
Master thesis
Name : Rizki Malinda Isvaniari Putri
ANR : 926723
Studies : MSc. International Management
Supervisor : Dr. Gerwin van der Laan
Second Reader : Dr. Shivaram Devarakonda
2
Abstract
This study begins with “one size does not fit all” concept which have analyze the corporate
governance mechanism on Multinational State Owned Enterprises (SOEs). In the sample of 49
Multinational SOEs in all over the world, this study contributes to the understanding of the
interaction of corporate governance mechanisms, especially in Multinational SOEs. The analysis of
internal and external corporate governance mechanism reveals that there are the significant
relationships between those mechanisms and firm financial performance in Multinational SOEs.
The study also found if there is an interaction effect between internal and external mechanism of
corporate governance that has a positive effect on the financial firm performance. Those findings
affirm if the internal and external of corporate governance mechanism appear to complete each
other instead of substitute each other. The result of this study also offered the optimal corporate
governance mechanism to Multinational SOEs and the reference for government to establish
corporate governance policy for SOEs, it must be considered that SOEs which will be or already
had internationally system have different corporate governance atmosphere compare to other state
owned enterprises and other multinational private firm.
3
Table of Contents
Abstract ........................................................................................................................................................ 2
Chapter 1 Introduction ............................................................................................................................... 4
1. Brief Literature .................................................................................................................................. 4
2. Research Question ............................................................................................................................ 6
Chapter 2 Theoretical Framework ............................................................................................................ 7
1. Corporate Governance in Multinational State Owned Enterprise (SOEs) ........................................ 7
2. Internal Mechanism of Corporate Governance in Multinational State Owned Enterprises (SOEs) . 9
3. External Mechanism of Corporate Governance in Multinational State Owned Enterprises (SOEs)12
4. Interaction Effect of Corporate Governance Mechanism ............................................................... 12
5. Multinational SOEs Firm Performance ........................................................................................... 13
Chapter 3 Methodology ............................................................................................................................ 15
1. Data Collection ............................................................................................................................... 15
2. Variables and Measurement ............................................................................................................ 15
3. Empirical Model ............................................................................................................................. 17
Chapter 4 Data Analysis and Results ...................................................................................................... 19
1. Statistical Results ............................................................................................................................ 19
2. Testing the Hypotheses ................................................................................................................... 20
3. Discussion ....................................................................................................................................... 22
4. Conclusion ...................................................................................................................................... 24
Table 1 : Hypotheses ........................................................................................................................................ 17
Table 2 : Descriptive Statistics......................................................................................................................... 19
Table 3: Correlation Matrix of the variables .................................................................................................... 20
Table 4: Regression Output ............................................................................................................................. 21
Table 5: Output Analysis ................................................................................................................................. 22
4
Chapter 1 Introduction
1. Brief Literature
Multinational corporations are recognized as the primary actors in the international
business and global economies. Mostly in the developed country, many State Owned
Enterprises (SOEs) jump from a national-based corporation into Multinational Corporation.
Some of those enterprises have chased overseas listings, some have entered into joint ventures
or firm contract with overseas companies, and others have expanded abroad through Merger &
Acquisitions, Greenfield investment or other forms of outbound direct investment (ODI).
Recently, many governments of the developing country also want to transform their SOEs into
Multinational Corporation. The rapidest growth of the Multinational SOEs happened in China
in recent years, which undoubtedly is still an emerging market. The first primary push factor for
‘going global’ of those Chinese SOEs is the central government’s policy and related incentives.
Following this phenomenon, many governments in other developing country have a goal to
transform their SOEs into the multinational enterprise.
Becoming Multinational Corporation is not an easy thing; several obstacles must be
facing such as the policy and knowledge constraint. Corporate governance is one of policy that
government, as SOEs shareholder, can influence in order to develop SOEs into a global scale
corporation. Having good corporate governance is one of the specifications for a company to be
a success in developing their business because corporate governance can reduce the agency
problem, which is a worldwide issue in every form of corporation.
Agency problems appear within a firm when managers have the incentive to reach their
interests at the shareholders’ expense. SOEs seem to suffer more severe agency problems than
private companies. SOEs are the company that was owned and controlled by government
agencies far removed from all citizens (including employees), this situation makes the
motivation for SOEs managers and employees to improve performance is not going maximize
because they can hardly get benefit from individually (Peng 2009). Furthermore, they will
experience “common agency” problem (Siqueira & Cauley, 2009) because they are supervised
by several levels of government, for example by a local government that owns them and the
sovereign state, or by both the state and minority shareholders with potentially have different
interest.
5
Several corporate governance mechanisms can reduce agency problems and also
increase firm performance (Agrawal and Knoeber 1996). The internal mechanism of corporate
governance encompasses the controlling mechanism between various actors inside the firm;
these mechanisms include oversight of management, independent internal audits, the board of
directors’ composition, and control and policy development. Moreover, the external control
mechanism is controlled by those outside an organization and serves the objectives of entities,
such as administrators, governments, trade unions and financial institutions (Al-Malkawi and
Pillai, 2012). These two mechanisms work together in a system to affect governance in firms.
Many SOEs today have become multinational in terms of the number of national
markets they serve, the number of countries in which they own or control producing facilities,
the foreign employee they have and even in ownership. Becoming global scale companies, the
governance of those SOEs also has fundamentally changed. Multinational SOEs must establish
and execute a larger number of governance mechanisms and instruments to cope with
globalizing needs and cross-country differences in governance norms. There is a concept “one
size doesn’t fit all”, which is not every company will be better if they implemented the same
corporate governance mechanism. According to Aguilera et al. (2003), the effectiveness of
corporate governance mechanisms depends on critical environmental variables. The firm
characteristic may imply different corporate governance mechanism choices, which explains
why the effect of corporate governance factors on firm performance varies from one study to
the other.
Corporate governance mechanism is a highly studied topic as far as private firms are
concerned, but has received little awareness in the context of Multinational SOEs; this study
contributes to our understanding of corporate governance mechanisms in multinational SOEs.
Realizing the effect of internal and external mechanisms and the model of corporate governance
among the Multinational SOEs will provide valuable information to top policy makers and
assist the government in the restructuring and making a policy of Multinational SOEs.
Consequently, this study also analyze the interaction effect between internal and
external mechanism of corporate governance which is can add the substance about how far
those mechanisms is complement each other or on the contrary substitute each other in
Multinational SOEs.
6
2. Research Question
This study will answer the research questions below:
a) Do internal mechanisms of corporate governance affect Multinational State-Owned
Enterprise financial performance?
b) Do external mechanisms of corporate governance affect Multinational State-Owned
Enterprise financial performance?
c) Does an interaction effect between internal and external mechanism of corporate
governance affect Multinational State-Owned Enterprise financial performance?
7
Chapter 2 Theoretical Framework
1. Corporate Governance in Multinational State Owned Enterprise (SOEs)
The state sectors have always been an important component of most economies in every
country. Recently, they progressively compete with private firms for resources, ideas, and
consumers in both domestic and international markets (Kowalski, P., et al., 2013). There are
two conservative explanations for the existence of SOEs, the one is SOEs as an economic one
that centers on the solution for market imperfections and the other SOEs as a political one that
focuses on the ideology and political strategy of government officials regarding the ownership
of particular productive assets (Cuervo-Cazurra, Inkpen et al. 2014). SOEs performance always
has a significant influence on country revenue and expenditure. In revenue side, SOEs have a
contribution to tax and non-tax revenue. Furthermore, if SOEs have the poor performance, it
will contribute to state expenditure. Because of those reasons, SOEs must have excellent
performance related to their function to serve public generally.
Furthermore, several SOEs are among the largest and fastest expanding multinational
companies. Multinational corporation governance views if openness to trade and investment can
create substantial economic gains for their business and the economy as a whole, by giving
access to better knowledge and cheaper resources, more efficient specialization and accelerating
competitive pressures that raise productivity (Kowalski et al., 2013). These benefits are believed
will give the same effect for state-owned businesses and may be an important driver for a recent
significant expansion of SOEs into international markets.
Wong (2004) explained if most of SOEs have governance weaknesses, one of them is
agency problem that lead to an increment of government intervention in SOEs governance.
Otherwise, the right of SOEs managers which is to supervise the company always being abused
because most of the managers of SOEs were chosen based on political interest and that lead the
manager has a dependence on government. This governance weakness makes the SOEs
performance less competitive than another private firm.
The core of modern corporate governance is the Agency Problem between outside
shareholders and inside managers. According to agency problem theory from Jensen and
Meckling (2006), there is asymmetric information between agent (in this case is CEO of SOEs)
8
which has more inside information about company position than principal (in this case are
society as tax-payer that is represented by government). Another problem appears as a conflict
of interest happened because of the agent will not always perform in the best interest of the
principal, this thing occurs due to both parties to the relationship are utility maximizer. To solve
this agency problem, the company must endure some agency cost. Consequently, administrators
establish governance and control mechanisms to prevent agents from acting opportunistically.
The principal can restrict those interest distinctions by creating appropriate incentives for the
agent and by incurring monitoring cost designed to limit the digression activities of the agent.
Corporate governance covers the way of organizing ownership, management, and control of
a corporation (Hinterhuber, Matzler et al. 2004). According to the definition of the OECD
(Organization for Economic Cooperation and Development, 2004, p.11), “Corporate
governance involves a set of relationships between a company’s management, its board, its
shareholders and other stakeholders. Corporate governance also provides the structure through
which the objectives of the company are set, and the means of attaining those objectives and
monitoring performance are determined”.
A study by Lins (2004), corporate governance mechanisms can be classified into two
categories. The first is particular sets of controls for a corporation come from its internal
mechanisms that observe the progress and activities of the organization and take corrective
actions when the business goes off track. An internal mechanism of corporate governance
involves various actors inside the firm. The next is an external control mechanism that are
controlled by those outside an organization (Al-Malkawi and Pillai 2012).
Recently, most SOEs jump from a local scale corporation into the multinational level.
Multinational corporations are enterprises that have a network owned of producing, marketing
or R&D affiliates located in some countries (Pathak 1989). There are some reasons why SOEs
may be progressively expanding into foreign markets, several of them relating to government
policies and some to internal factors concerning these firms as well as dynamics of markets in
which SOEs operate (Kowalski 2013). Luo (2007) stated if corporate governance in
multinational companies differs from that in domestic firms. Multinational corporations face
heterogeneous corporate governance standards institutionalized by different countries
throughout the world. Furthermore, the governance of SOEs will be critical to ensure their
positive contribution to a country’s overall economic efficiency and competitiveness. As state
9
owned enterprises become more globalized, they require more attention to develop their
corporate governance mechanism due to the need to fulfill various stakeholder interests,
involved regulation in the host country and home country government materiality.
2. Internal Mechanism of Corporate Governance in Multinational State Owned Enterprises
(SOEs)
Internal mechanisms of corporate governance is the way of companies to conduct a
monitoring mechanisms between various actors inside the firm: the firm’s management, its
board, and the shareholders (Booth, Cornett et al. 2002). The research that conducted by Choi
and Dow (2008) and Rashid and Islam (2008) use board size and CEO duality as tools for the
internal mechanism of corporate governance. Board size and CEO duality are two important
keys of internal corporate governance that influence the firm’s decisions to the other
stakeholders especially on Multinational SOEs, it happens because culture and political action
are related to these variables (Tanoos, 2013).
a. Board Composition
Recently, the fundamental trend in SOE governance has been to enlighten the roles of
the state, ownership entities, boards and management (Frederick, 2011). The most
prominent governance mechanism that can make and impact on the manager performance is
the board of directors, whose charge is to represent the shareholders. The board of directors
is the ultimate decision making institute of a corporate firm. The members of the Board of
Directors are elected by shareholders, and the shareholders delegate the power that is
accountable to them.
The board of director in SOEs handles the performance of the SOE. Its duty is to ensure
that the SOEs achieves the strategic objectives as contracted with the line minister while at
the same time reaching its commercial goals. The Board also has authority to remove
executive directors, decide about CEO compensation and give approval to major strategic
decisions and firm’s capital structure like stock repurchases or new debt issues, that is why
they are necessary for internal mechanism of corporate governance to monitor and
discipline management (Baysinger and Hoskisson 1990).
Although have same aspects in their structure and functioning, boards of directors in
Multinational SOEs usually do not participate in the same activities they undertake in
10
private companies. At best, Multinational SOEs’ boards may act as a kind of organization
body that represents the interests of employees, several ministries, and in some cases, non-
state shareholders. The Organization for Economic Co-operation and Development (OECD)
Guidelines on Corporate Governance of State-Owned Enterprises propose a board is
charged by the state with observing the development of a strategy to achieve the state’s
objectives and monitoring of progress. Related to political influence, the presence of
politicians on the board in SOEs is guaranteed by the direct and indirect control of the firm.
Politicians might assist the firm in reaching a higher economic result by predicting the
government’s actions or when the firm’s revenues rely on the political process, as in the
case of agreements with public institutions.
Based on a new study by Governance Metrics International (GMI) Ratings for Wall
Street Journal 2014, bigger is not always better in the boardroom. Eisenberg, Sundgren et al.
(1998) also explained if there is negative relationship between board size and firm
performance, this condition is driven by the effect of board size in coordination,
communication, and decision making process. As the board becomes larger, there are more
conflicts of interest in decision making because most board members also become passive
and lazy denying on their duties to provide resources (Jensen, 1993). Yermack (1996) also
found that firms with small boards have increased the quality of monitoring and decision
making by the board of directors. Small boards are more likely to retire CEOs for poor
performance that this threat declines significantly as boards grow in numbers. This
condition leads to the first hypothesis in this study.
H1: There is negative relationship between Board Size and Firm Performance
b. CEO Duality
A Chief Executive Officer (CEO) is the highest-ranking executive in charge of the total
management of a corporation. The CEO is responsible for the success or failure of the
corporate. Mostly, the CEO provides the company's operating plan and projected budget
with the guidance and approval of the board, and then CEO will making a report to a board
of directors. The CEO cannot refuse board requests unless they are illegal or violate the
corporation bylaws. The appearance of CEO on Multinational SOEs is crucial because the
11
executives must choose their objectives carefully to emphasize the urgency and plow
through the bureaucratic inertia that’s common in state enterprises.
Furthermore, in the board composition there is chairman of the board that is the most
influential member of the board of directors who conducts leadership to the firm's officers
and executives. Generally, chairman is elected by board of directors at board meeting and
shareholder meeting, but mostly in SOEs both chairman and CEO will be appointed by the
government. Different from CEO, chairman typically utilizes substantial power in setting
the board's agenda and deciding the outcome of votes, but chairman does not necessarily
play an active role in everyday management.
There is one condition when those two most powerful positions in the company, the
chairman of the board and the CEO, are combined and held by one person which is called
CEO Duality (Daily and Dalton 1992). CEO duality is chosen for the second internal
mechanism of corporate governance in this study. CEO duality is an important subject in
corporate governance because the status condition of the CEO and chairman may have an
effect on firm performance. Once the same person holds the CEO and the chairman of the
board position together, he or she could use the authority as a board chair to choose the
directors that preferred which are usually the people who are in favor of him or her and less
likely to stimulate his or her decisions (Peng, Zhang et al. 2007).
The question of whether the CEO can also be the chairman of the Board of Directors is
regarded very differentially internationally. According to organization theory, that CEO
duality establishes strong, unambiguous stimulates leadership. But according to agency
theory, this condition will enhance CEO deficiency by reducing board monitoring
effectiveness (Finkelstein and D'aveni 1994).
Furthermore, the key findings from Sanders and Mason (1998) suggest that
multinational companies are more likely to detached the positions of chairman of the board
and CEO, rather than combine them into one position. Separating the two positions in
multinational companies allows for greater dimensions of expertise and information than
would be possible if one person held both positions. Kiel and Nicholson (2003) also found a
negative relationship between CEO duality and firm performance. That series of research
make the second hypothesis.
12
H2: There is negative relationship between CEO Duality and Firm Performance
3. External Mechanism of Corporate Governance in Multinational State Owned Enterprises
(SOEs)
The external mechanism involves the outsiders of the company; debt policy is used as a
corporate governance mechanism to reduce agency conflict (Jensen and Meckling 1976, Faccio,
Lang et al. 2001). Bank financing is getting more necessary for Multinational SOEs as
government budgetary grants played a less and less important role (Cull, 2000). The
government as a shareholder and/or CEO and board director of the firms may influence the
chosen of bank debt as a part of the capital structure on Multinational SOEs.
Jensen and Meckling (1976) stated that debt cause a bonding mechanism for the managers
to bring good results for the shareholders, by not creating an opportunity to diverge from the
corporations’ free cash flow. The larger the loans, the more cash the firms will have to pay for
the interest and installment. Debt that taking by the managers will cause risks to the company if
the managers fail to perform an effectively (Dharmastuti and Wahyudi 2013). Thus, the debt
will shift management’s monitoring from shareholders to creditors. This monitoring forces the
management or shareholders to conduct actions that can give benefit to the firm.
Moreover, the announcement of a bank credit agreement conveys the positive news to the
stock market about creditor’s worthiness. Fama (1985) found if bank lenders have a
comparative advantage in reducing information costs and getting access to information not
otherwise publicly available. Bank debts may be value-enhancing for borrowers if the lenders
provide monitoring functions for the borrowing firms, especially when the company has weak
internal governance structures. From that information, the third hypothesis of this study states
bank debt as an external mechanism of corporate governance will enhance firm performance
(Uchida 2008).
H3: There is positive relationship between Bank Debt and Firm Performance
4. Interaction Effect of Corporate Governance Mechanism
Interaction effect happens when the impact of one variable depends on the level of the other
variable. The asymmetric information between shareholder, manager, and debt holder will lead
to the interaction effect between internal and external mechanism of corporate governance.
13
This asymmetric information comprises the prospect of the company and manager effort. The
future of the company is reflected by more investment opportunity given that is detected by the
investor through external funding in the capital structure of the enterprise. Otherwise, Pecking
Order Theory that was developed by Myers and Majluf (1984) explained if manager prefer to
use retained earnings (internal funding) when it comes to capital structure and after that
manager will choose debt or equity (external funding) as a last resort.
According to Ranti (2013), the large board size has difficulty in achieving a consensus in
decision which will affect the quality of corporate governance and will translate into higher
external debt levels to enhance firm value. The company value will be increasing because the
debt will give signal to the investor, which is the higher of debt that company owned so the
manager more ensure if the company has brighter future than the company who has lower in
debt financing, and it will give positive influence to the company stock price. Furthermore,
Fosberg (2004) and Abor (2007) argued if CEO duality will increase firm’s debt usage. The
duality leadership will reduce the problem related to separation of ownership and control, so the
CEO duality companies will have high accessibility to external financing (Ranti, 2013). Those
explanations establish fourth and fifth hypothesis of this study which is if there is an interaction
effect between internal and external mechanism of corporate governance.
H4: There is positive interaction effect between Board Size and Bank Debt into Firm
Performance
H5: There is positive interaction effect between CEO Duality and Bank Debt into Firm
Performance
5. Multinational SOEs Firm Performance
Every corporate have the same goal that is to enhance firm performance. Economic
performance is one of dimension goals of Multinational SOEs beside of social performance
(Aharoni, 1981). The Global Investor Opinion Survey on 2002 that is released by McKinsey &
Company found that investors state they still locate corporate governance on a par with
14
financial indicators when evaluating investment decisions and more than 60% of the
respondents would pay premium for well-governed companies. Previous studies (Agrawal and
Knoeber 1996, Klapper and Love 2004, Cremers 2005) have established a positive relationship
between good corporate governance and coporate performance. Moreover, Mitton (2000) found
if the variables related to corporate governance had a significant association on firm
performance during the East Asian financial crisis of 1997-1998. Gompers et al. (2003) also
found the positive result between corporate governance indexes with long-term corporate
performance.
15
Chapter 3 Methodology
1. Data Collection
According to He (2010), a multinational SOEs is a multinational enterprise with at least 10
percent of state ownership. This 10-percent cutoff is high enough that the state should have the
ability to influence corporate governance and, therefore, firm performance. The study that was
conducted by Cuervo-Cazurra, Inkpen et al. (2014) showed that there are 49 largest non-
financial multinational SOEs in 2010 which divided into government as a majority shareholder
and government as a minority shareholder. Those companies will be used as sample in this
research, and the period that will be used is from the 2010-2013 year period. The period has
been selected because the Multinational SOEs is having a significant increase after the global
financial crisis in 2008.
The data that be used in this research are a combination of time series and cross-section
data. This study uses secondary data for total asset, board size, CEO duality, debt to total assets
ratio, and ROA that have been taken from published company annual reports, especially on
Corporate Governance session. This research also uses the data that is provided by ORBIS and
COMPUSTAT database. The firm with incomplete and inconsistent data will be excluded from
this research.
2. Variables and Measurement
a. Independent Variable and Measurement
For the empirical evidence on the influence of corporate governance mechanism on
firm performance, quantitative research needs to be done. In this study, the independent
variables are board size, CEO duality, and bank debt.
Board size will be measured by the total number of directors (Board size). This research
will use the logarithm of board size, as do previous studies which show that the relationship
between board size and performance is convex rather than linear (Yermack 1996).
Furthermore, CEO duality is a dummy variable for the purpose of analysis. If CEO duality
is identified for one company, a dummy variable is defined as “1”, and if the functions of
CEO and the chairman of the board are separated, then a dummy variable is coded as “0”.
16
For bank debt will be measured by the total bank debt to total assets ratio. All of that
information has been taken from the company annual reports.
b. Dependent Variable and Measurement
The dependent variable that is used in this study is financial firm performance. The
study held by Ramdani (2010) evaluated firm performance by using the average value of
return on assets (ROA). ROA apparently takes into account the assets used to support
business activities. It determines whether the company able to generate a sufficient return on
these assets rather than merely showing a robust return on sales. Using ROA as an important
performance metric quickly focuses management attention on the assets required to run the
business, this prediction is in line with the study of the corporate governance which is
focusing on how good is the management in one company. The higher the ROA number, the
better, because the company is earning more money on less investment. Using ROA, it can
be known if management's most important job is to make important decisions in allocating
its resources. Every management can make a profit by using the money to solve the
problem, but just very good management outplay at making large profits with little
investment. This study uses the ROA value for each company in the particular period from
the ORBIS database.
c. Interaction Effect and Measurement
When an interaction effect is provided, the impact of one variable depends on the
level of the other variable. This study will measure the two-way interaction effect between
bank debt into board size and CEO duality, and also the relationship between those
interactions into ROA. In order to examine this interaction effect, this study will generate
new variables such as Board Size – Bank Debt and CEO Duality – Bank Debt.
d. Control Variable and Measurement
It is not possible that corporate governance mechanism will be the only variable that
influences firm performance. Another factor will influence firm performance as well. For
this purpose the size of the company has been selected, because it could be an important
factor that affects how corporate governance mechanisms influence the firm performance.
17
Pervan and Jossipa (2012) found if there is a positive relationship between firm size and
firms’ performance. Firm size is proxied by the logarithm of total assets of the firm (Braun
and Sharma 2007).
The summary of hypotheses can be shown in this table:
Table 1 : Hypotheses
Hypotheses Independent Variable Relationship
H1 Board Size Negative
H2 CEO Duality Negative
H3 Bank Debt Positive
H4 Interaction Effect of Board Size and Bank Debt Positive
H5 Interaction Effect of CEO Duality and Bank Debt Positive
Figure 1 : Conceptual Framework
3. Empirical Model
Based on a combination of cross-sectional and time-series data, panel data regression
techniques were used to analyze the performance of the firms. The software that will be used to
make regression analysis is STATA 13.
18
Panel data are data for multiple entities in which entity is observed at more than one period
(Stock and Watson 2007). The number of units in a panel data set is denoted by n, and the
number of time period is denoted by T. In this research data set, we will have observations on
n=49 Multinational SOEs and T=4 years from 2010-2013 period. Thus there is a total estimated
of n x T = 49 x 4 = 196 observations.
For the first three hypotheses, this research will modeling the relationship between
dependent variable and one independent variable, so in this case the model that will be used is
linear regression model. The equation model is mentioned below:
Yit = β0 + β1Xit + Uit t = 1, 2, ....., T ; i = 1, 2, ….., n.
Where Yit is the dependent variable, β0 is an intercept, β1 is the slope of the population
regression line, and Xit is the independent variable, and Uit is the error term.
Hypotheses 1 until hypotheses 3 will be tested by linear regression model as mentioned below:
Yit = α + β1CZit + β2BZit ++ β3CDit + β4BDit +Uit
An interaction occurs when the dimension of the effect of one independent variable on a
dependent variable varies as a function of a second independent variable. The regression
equation used to analyze and interpret a 2-way interaction is:
Where is:
Yit : Financial firm performance in company i on year of t that will be proxied by
ROA
β0 : Intercept
Czit : Company size in company i in the year of t that will be proxied by the
logarithm of total asset
BZit : board size in company i in the year of t that will be proxied by the number of
people on the board
CDit : CEO duality in company i on year of t that will be proxied by dummy variable
which is 1 if there is CEO duality and 0 if not
BDit : bank debt in company i in the year of t that will be proxied by total bank debt
to total assets ratio
BZit BDit : the new variable for investigate two-way interaction effect of board size and
bank debt in company i in the year of t
CDit BDit : the new variable for investigate two-way interaction effect of CEO duality
and bank debt in company i in the year of t
Yit = β0 + β1CZit +β2BZit + β3CDit + β4BDit + β24 BZit BDit + β34 CDit BDit + Uit
19
Chapter 4 Data Analysis and Results
1. Statistical Results
The descriptive summary is presented in Table 2. From this table, it can be seen if
most Multinational SOEs employ the no CEO Duality structure (147 observations) than CEO
Duality (49 Observations). For board size variable, it can be seen if the means of the board
size for this sample is around 12 people that sit on the board. The bank debt variable
indicating if the multinational SOEs maintain their leverage ratio because the means of this
variable is just around 13% for this sample, it proves if SOEs investment was financed
mainly from interest-free budgetary grants and retained profits. Banks were not really
important a source of funds (Cull, 2000). There is also vary on Multinational SOEs financial
performance which is the mean is only 6.57% that implying if most of multinational SOEs is
still underperformance.
Table 2 : Descriptive Statistics
Variable Definition Descriptive
Statistic
Multinational
SOEs
Dependent
Variable ROA
The return on assets is an accounting
measure of profitability and efficiency,
this variable being defined as earnings
before interest and tax (EBIT) divided
by total assets (book value).
Min -0.0687
Max 0.9258
Mean 0.0657
Stdev 0.1083
Independent
Variable:
Internal
Mechanism of
Corporate
Governance
Board
Size
The total number of directors in one
period in one company
Min 5
Max 22
Mean 11.77
Stdev 3.612
CEO
Duality
The condition when the two most
powerful positions in the company. the
chairman of the board and the CEO are
combined and held by one person
Number of CEO
Duality 49
Number of
NonCEO Duality
147
20
Variable Definition Descriptive
Statistic
Multinational
SOEs
Independent
Variable:
External
Mechanism of
Corporate
Governance
Bank
Debt The total bank debt to asset ratio
Min 0.0000863
Max 0.5388
Mean 0.1349
Stdev 0.1265
N 196
The correlation between variables is presented in Table 3. Correlations measure the
strength and direction of the linear relationship between the two variables. From this table, it
can be seen if Bank Debt variable and Log Total Assets has the higher correlation than the
other variables.
Table 3: Correlation Matrix of the variables
ROA Log Total Assets Log Board Size CEO Duality Bank Debt
ROA 1.0000 0.1879 -0.0885 -0.1211 -0.1717
Log Total Assets 0.1879 1.0000 0.1262 0.2855 -0.3187
Log Board Size -0.0885 0.1262 1.0000 0.2302 0.1956
CEO Duality -0.1211 0.2855 0.2302 1.0000 -0.0496
Bank Debt -0.1717 -0.3187 0.1956 -0.0496 1.0000
2. Testing the Hypotheses
The first thing that have must be done before doing the estimation and comparing the
coefficient signal is to determine what linear regression model that suitable for this study.
Chow test and Hausman test has been done for choose the regression model that is used.
From those test, the use of Random Effect Model for overall samples gives a more
significant result for this study. In a random effects model, the unobserved variables are
assumed to be uncorrelated with all the observed variables. Below is the output of regression
coefficient estimation.
21
Table 4: Regression Output
Variable Model 1:
Control Variable
Model 2:
Independent Variable
Model 3:
Interaction Effect
Log Total Assets 0.0311
(0.0245)
0.0285
(0.0283)
0.0241
(0.0285)
Log Board Size -0.0781
(0.0983)
-0.1228
(0.1476)
CEO Duality -0.0185
(0.0206)
-0.0411*
(0.0244)
Bank Debt -0.1626*
(0.0837)
-0.3411
(0.6911)
Log Board Size – Bank Debt 0.1416
(0.6227)
CEO Duality – Bank Debt 0.2292**
(0.1097)
R2 0.0353 0.0699 0.0688
Table 4: Results of random effect model regression of panel data of Log Total Assets, Log Board Size, CEO Duality, Bank
Debt, Log Board Size – Bank Debt, and CEO Duality – Bank Debt on ROA. Standard Errors are displayed in brackets.
Significant at levels:
* p<0.10
** p<0.05
If the variable has p-value < α it comes to significant influence, on the other hand if the p-
value > α so the variable has no significant influence. Based on p-value from each coefficient
variable, it can be known how each independent variable influence into a dependent variable.
From the table above, there is none independent variable that has a significant influence on
the dependent variable.
Using 90% and 95% of confidence level, it can be seen if some variables have not
significant result such as Log Total Assets, Log Board Size, and the interaction between
Board Size and Bank Debt. On the other hand, the variables like CEO Duality, Bank Debt
and the interaction effect between CEO Duality and Bank Debt have a significant
relationship with the ROA.
22
3. Discussion
Table 5 summarizes the hypothesis and the result of this study. From the table, it can be
seen the prediction that is made in hypothesis and the result after doing the regression.
Table 5: Output Analysis
Relationship Between Corporate Governance and Firm Performance in Multinational SOEs
Independent Variable Prediction Result
Internal
Mechanism
Board Size - -
Not significant
CEO Duality - -
Significant
External
Mechanism Bank Debt +
-
Significant
Interaction
Effect
Board Size –Bank Debt + +
Not Significant
CEO Duality – Bank Debt + +
Significant
a. Internal Mechanism of Corporate Governance
The internal mechanism of corporate governance is the way of companies to
conduct a monitoring mechanism between various actors inside the firm. On this study,
the proxies of this mechanism are the logarithm of board director size and CEO duality
that corporate had. The hypothesis of this study stated if small number of board director
size and the non-CEO duality can enhance the firm performance that would be
represented by corporate ROA.
From the second model regression output, it shows if there are no significant
relationships between those variables with firm performance. But when the simultaneous
regression is utilized with the interaction variables, the result show if CEO Duality has a
significant negative relationship with ROA. This implies if the ROA is higher if there is
no CEO Duality on the firm. This finding is in line with the study by Sanders and Mason
(1998) if Multinational SOE have greater dimensions of expertise and information with
implementing the no CEO Duality than if there is one person held two position as
chairman and CEO. This condition will lead to higher firm performance for Multinational
SOEs because the variety of information, knowledge, and expertise are needed for
Multinational SOEs as a global competitive advantage.
23
This result does not support the first hypothesis but supports the second
hypothesis of this study. It can indicate if internal mechanisms have an effect on financial
firm performance in Multinational SOEs.
b. External Mechanism of Corporate Governance
Moreover, the regression result for the external mechanism of corporate
governance rejected the third hypothesis of this study. Instead of having a positive
relationship, bank debt ratio has significant negative relationship into ROA, implying that
ROA is lower in the high bank debt ratio firm. This relationship happened because bank
debt as monitored debt reduces some agency costs but introduces other expenses
(Anderson & Makhija, 1999). One of these costs may related to the risk management of
government, because of debt on Multinational SOEs can become a contingent liability for
Government, and so if corporate fail to pay their debts, the Government is usually obliged
to make the payments and it will lead to high political risk, so the result is the firm will
maintain their leverage ratio to avoid that risk. Moreover, the multinational SOEs also
face differing tax incentives and legal regimes around the world, making them possible to
identify the impact of several factors on financing choices on their capital structure.
External debt is more costly in environments in which creditor rights are weak and
locally available external debt is scarce (Desai & Hines, 2004). In the end, it can be
concluded if external mechanisms have an effect on financial firm performance in
Multinational SOEs.
c. Interaction Effect on Mechanism of Corporate Governance
Although the interaction effect between Board Size and Bank Debt does not have
a significant relationship with ROA, but the interaction effect between CEO Duality and
Bank Debt have a significant positive relationship with firm performance. This result
supported the fifth hypothesis of this study and indicated if there is an interaction effect
between internal and external mechanism of corporate governance that affect
Multinational State-Owned Enterprise financial performance.
According to Ranti (2013), the duality leadership will reduce the problem related
to separation of ownership and control, so the CEO duality companies will have high
24
accessibility to external financing. Furthermore, Fama (1985) found if bank lenders have
a comparative advantage in reducing information costs and getting access to information
not otherwise publicly available, this condition will enhance the performance of the firm.
Multinational SOEs that have CEO Duality will employ more external debt to their
capital structure that less costly than issued the equity, this condition will lead to higher
financial firm performance.
4. Conclusion
There is a broad literature that covers many aspects of corporate governance mechanisms
in order to alleviate the agency conflicts, such as board of director composition, managerial
incentives, capital structure, corporate regulations, and market for corporate control. Using
non-financial Multinational SOEs between 2010 and 2013 period, this study investigates if
the internal mechanism and external mechanism of corporate governance affect firm financial
performance in Multinational SOEs, and this study also want to analyze if there is interaction
effect between those mechanisms that will affect to financial firm performance in
Multinational SOEs.
Evidence from this study found if the internal mechanisms (CEO Duality) and external
mechanisms (Bank Debt) of corporate governance have an impact to the firm financial
performance (ROA) in Multinational SOEs. CEO Duality has a significant negative
relationship to ROA due to Multinational SOEs need the greater dimensions of expertise and
information by applying the no CEO Duality. Moreover, bank debt has significant negative
relationship to the ROA because for Multinational SOEs the high leverage ratio leads to the
higher political risk for the government, as shareholder, so to achieve the good firm
performance the Multinational SOEs will maintain their leverage ratio to avoid that risk.
This study also found if there is an interaction effect between internal (CEO Duality) and
external (Bank Debt) mechanisms of corporate governance that have the positive impact on
financial firm performance (ROA) in Multinational SOEs. The positive interaction effect
between CEO Duality and Bank Debt that have influence to ROA confirms the fifth
hypothesis of this study, this result indicate if the position of CEO and Chairman is held by
one person it will increase the external debt usage and lead to higher performance for the
25
corporate. This finding affirms if the internal and external of corporate governance
mechanism is completing each other instead of eliminating or substituting each other.
The findings of this study add insight for both theoretical understanding and corporate
governance practices; also it found the connections to the performance and behavior of
Multinational SOEs. The result also offered the optimal corporate governance mechanism to
Multinational SOEs with the lower bank debt will lead to higher financial performance of the
firm and CEO Duality can be good for the leveraged firm. This study also implies the
government as shareholder and administrator should be careful not to design strict ‘one size
fits all’ corporate governance rules, they must consider the SOEs that will be or already had
internationally system have different corporate governance atmosphere compare to other
state owned enterprise and other multinational private firm.
In general, there are two main limitations to this study. First, the number of observations
is small because the main focus of this study is multinational companies that have the state as
their owner (Multinational State Owned Enterprises). The number of this type of company
still fewer than the number of the multinational corporations or the state owned enterprise
itself, this happened because Multinational SOEs is a new phenomenon in international
business. Second, the result are not generalizable for all Multinational SOEs, because this
study just use the non-financial Multinational SOEs and exclude the financial companies
since the samples follow the research that has been done by Cuervo-Cazurra, Inkpen et al.
(2014).
The suggestions for the further study are involving the other variables as internal and
external mechanisms of corporate governance and examine similar relations in the
comparable non-SOEs corporation.
26
References
Abor. J. (2007). "Corporate governance and financing decisions of Ghanaian listed firms."
Corporate Governance 7(1): 83-92.
Agrawal. A. and C. R. Knoeber (1996). "Firm Performance and Mechanisms to Control Agency
Problems between Managers and Shareholders." The Journal of Financial and Quantitative
Analysis 31(3): 377-397.
Aharoni, Y. 1981. "Performance evaluation of state-owned enterprises: A process perspective".
Management Science, 27: 1340–1347.
Al-Malkawi. H.-A. N. and R. Pillai (2012). "Internal Mechanisms of Corporate Governance and
Firm Performance: A Review of Theory and Empirical Evidence." Journal of Modern
Accounting and Auditing 8(4): 549-568.
Anderson, C. W., & Makhija, A. K. (1999). "Deregulation, disintermediation, and agency costs
of debt: evidence from Japan." Journal of Financial Economics, 51(2), 309-339.
Baysinger. B. and R. E. Hoskisson (1990). "The composition of boards of directors and strategic
control: Effects on corporate strategy." Academy of Management review 15(1): 72-87.
Booth. J. R.. et al. (2002). "Boards of directors. Ownership. and regulation." Journal of Banking
& Finance 26(10): 1973-1996.
Braun. M. and A. Sharma (2007). "Should the CEO also be chair of the board? An empirical
examination of family‐controlled public firms." Family Business Review 20(2): 111-126.
Choi. J. J. and S. Dow (2008). "Institutional approach to global corporate governance: business
systems and beyond." Emerald Group Publishing.
Cremers. K. J. (2005). "Governance mechanisms and equity prices." Journal of Finance. The
60(6).
Cuervo-Cazurra. A.. et al. (2014). "Governments as owners: State-owned multinational
companies." J Int Bus Stud 45(8): 919-942.
27
Cull, R., & Xu, L. C. (2000). "Bureaucrats, state banks, and the efficiency of credit allocation:
The experience of Chinese state-owned enterprises". Journal of Comparative Economics, 28(1),
1-31.
Daily. C. M. and D. R. Dalton (1992). "The relationship between governance structure and
corporate performance in entrepreneurial firms." Journal of Business Venturing 7(5): 375-386.
Desai, M. A., Foley, C. F., & Hines, J. R. (2004). "A multinational perspective on capital
structure choice and internal capital markets." The Journal of Finance, 59(6), 2451-2487.
Dharmastuti. C. and S. Wahyudi (2013). "The Effectivity of Internal and External Corporate
Governance Mechanisms Towards Corporate Performance." Research Journal of Finance and
Accounting 4(4): 132-139.
Eisenberg. T.. et al. (1998). "Larger board size and decreasing firm value in small firms." Journal
of Financial Economics 48(1): 35-54.
Enriques. L. and P. Volpin (2007). "Corporate governance reforms in continental Europe." The
Journal of Economic Perspectives 21(1): 117-140.
Faccio. M.. et al. (2001). "Debt and corporate governance". Meetings of Association of Financial
Economics in New Orleans.
Fama. E. F. (1985). "What's different about banks?" Journal of Monetary Economics 15(1): 29-
39.
Finkelstein. S. and R. A. D'aveni (1994). "CEO duality as a double-edged sword: How boards of
directors balance entrenchment avoidance and unity of command." Academy of Management
Journal 37(5): 1079-1108.
Fosberg. R. H. (2004). "Agency problems and debt financing: leadership structure effects."
Corporate Governance 4(1): 31-38.
Frederick, W. (2011), “Enhancing the Role of the Boards of Directors of State-Owned
Enterprises”, OECD Corporate Governance Working Papers, No. 2, OECD Publishing.
He. X. (2010). "State Multinationals: The Impact of State Ownership on International
Diversification and Firm Performance." Doctoral dissertation. Texas A&M University.
Hinterhuber. H. H.. et al. (2004). "Corporate governance in multinational companies."
International Institutions and Multinational Enterprises–Global Players–Global Markets: 47-63.
28
Jensen. M. C. (1993). "The modern industrial revolution. exit. and the failure of internal control
systems." the Journal of Finance 48(3): 831-880.
Jensen. M. C. and W. H. Meckling (1976). "Theory of the firm: Managerial behavior. agency
costs and ownership structure." Journal of Financial Economics 3(4): 305-360.
Jungmann. C. (2006). "The Effectiveness of Corporate Governance in One-Tier and Two-Tier
Board Systems–Evidence from the UK and Germany–." European Company and Financial Law
Review 3(4): 426-474.
Kiel. G. C. and G. J. Nicholson (2003). "Board Composition and Corporate Performance: how
the Australian experience informs contrasting theories of corporate governance." Corporate
Governance: An International Review 11(3): 189-205.
Klapper. L. F. and I. Love (2004). "Corporate governance. investor protection. and performance
in emerging markets." Journal of Corporate Finance 10(5): 703-728.
Kowalski. P. (2013). "State-owned enterprises : trade effects and policy implications". Paris :
OECD.
Li, S., Fetscherin, M., Alon, I., Lattemann, C., & Yeh, K. (2010). "Corporate social
responsibility in emerging markets". Management international review, 50(5), 635-654.
Lins. K. V. W. F. E. (2004). "Corporate governance and the shareholder base". Washington
(D.C.). Board of governors of the Federal reserve system.
Luo. Y. (2007). "Global Dimensions of Corporate Governance". Blackwell Pub.
Millet‐Reyes. B. and R. Zhao (2010). "A Comparison Between One‐Tier and Two‐Tier Board
Structures in France." Journal of International Financial Management & Accounting 21(3): 279-
310.
Myers. S. C. and N. S. Majluf (1984). "Corporate financing and investment decisions when firms
have information that investors do not have." Journal of financial economics 13(2): 187-221.
Pathak. A. (1989). "International Dimensions of Management". PWS Kent Publishing Company.
Boston.
Peng. M. W. (2009). "Global strategic management". South-Western. Cengage Learning.
29
Peng. M. W.. et al. (2007). "CEO duality and firm performance during china's institutional
transitions." Management and Organization Review 3(2): 205-225.
Ramdani. D. (2010). "The impact of board independence and CEO duality on firm performance:
a quantile regression analysis for Indonesia. Malaysia. South Korea and Thailand." British
Journal of Management 21(3).
Ranti. U. O. (2013). "The Effects of Board Size and CEO Duality on Firms’ Capital Structure: A
Study of Selected Listed Firms in Nigeria." Asian Economic and Financial Review 3(8): 1033-
1043.
Rashid. K. and S. M. Islam (2008). "Corporate governance and firm value: Econometric
modelling and analysis of emerging and developed financial markets". Emerald Group
Publishing.
Sanders. W. M. G. and A. C. Mason (1998). "Internationalization and Firm Governance: The
Roles of CEO Compensation. Top Team Composition. and Board Structure." The Academy of
Management Journal 41(2): 158-178.
Siqueira, K., Sandler, T., & Cauley, J. (2009). "Common agency and state-
owned enterprise reform". China Economic Review, 20(2), 208-217.
Stock. J. H. and M. W. Watson (2007). "Introduction to econometrics". Boston. Pearson/Addison
Wesley.
Tanoos, James. (2013). " Multinational Corporation Adherence to the Duality Management
Structure in Japan versus the United States". Asian Journal of Business and Management
Sciences Vol. 2 No. 3 [43-49].
Tripathi. S. (2013). "Comparative Board Structures Under Corporate Governance Framework."
Available at SSRN 2282924.
Uchida. K. (2008). "Managerial ownership. debt. and firm performance in Japan." Pauline V.
Urlacher (eds.).New Issues in Corporate Governance 02: 14.
Wong. S. C. (2004). "Improving corporate governance in SOEs: An integrated approach."
Corporate Governance International 7(2): 19-29.
30
The World Bank, 2006. Held by the visible hand. The challenge of SOE corporate governance
for emerging markets. The World Bank, Corporate Governance, May 2006.
Yermack. D. (1996). "Higher market valuation of companies with a small board of directors."
Journal of financial economics 40(2): 185-211.
Zajac. E. J. and J. D. Westphal (1994). "The costs and benefits of managerial incentives and
monitoring in large US corporations: When is more not better?" Strategic management journal
15(S1): 121-142.
31
Appendix
List of Multinational SOEs
Multinational SOEs Industry Country
1 Petroleo Brasileiro SA Natural resources Brazil
2 Vale SA Mining Brazil
3 CITIC Diversified China
4 China Ocean Shipping Transportation, Shipping and storage China
5 China National Petroleum Natural resources China
6 Sinochem Group Natural resources China
7 China National Offshore Oil Corp. Natural resources China
8 China Railway Construction Corporation Construction China
9 China Minmetals Corp. Natural resources China
10 Lenovo Group Electrical and electronic equipment China
11 ZTE Corporation Telecommunications China
12 TPV Technology Limited Wholesale trade China
13 China Resources Enterprises Natural resources HK/China
14 First Pacific Company Limited Electrical and electronic equipment HK/China
15 Électricité de France Utilities France
16 GDF Suez Utilities France
17 France Telecom Telecommunications France
18 Veolia Environnement SA Electricity, gas and water France
19 Renault Automobile France
20 Volkswagen Group Automobile Germany
21 Deutsche Telekom AG Telecommunications Germany
22 Deutsche Post Transportation, shipping and storage Germany
23 Oil and Natural Gas Corporation Natural resources India
24 Tata Steel Ltd. Metal and metal products India
25 EnelSpA Electricity, gas and water Italy
26 Eni Group Natural resources Italy
27 Japan Tobacco Inc. Food/processing Japan
28 Zain Telecommunications Kuwait
29 Agility Public Warehousing Company Construction and real estate Kuwait
30 Petroliam Nasional Berhad (Petronas) Natural resources Malaysia
31 Axiata Telecommunications Malaysia
32 Sime Darby Berhad Diversified Malaysia
33 Statoil AS Natural resources Norway
34 Qatar Telecom Telecommunications Qatar
35 VimpelCom Telecommunications Russian
36 Singapore Telecommunications Ltd. Telecommunications Singapore
32
Multinational SOEs Industry Country
37 Neptune Orient Lines Ltd. Transport and Storage Singapore
38 Capital and Limited Construction and real estate Singapore
39 MTN Group Limited Telecommunications South Africa
40 Sasol Limited Chemicals South Africa
41 Steinhoff International Holdings Diversified South Africa
42 Sappi Limited Wood and paper products South Africa
43 Vattenfall AB Electricity, gas and water Sweden
44 TeliaSonera AB Telecommunications Sweden
45 Eads Defense The Netherlands
46 Abu Dhabi National Energy Company Utilities UAE
47 DP World Limited Transport and Storage UAE
48 General Motors Automobile USA
49 Petróleos de Venezuela SA Natural resources Venezuela