Governance_Philippines
Working Paper version of my Paper
“Relationship between Corporate Governance and Financial
Performance: An Exploratory Study of Philippine Companies”
to be read at the International Journal of Arts & Sciences Conferences,
22 June 2009, Suffolk University, Boston MA, USA
Corporate governance is an area that has grown rapidly in the last few years. Recent accountability failures in the U.S. and other countries have led to bankruptcies and restatements of financial statements that have harmed countless shareholders, employees, pensioners, and other stakeholders. A good number of well-known corporations have lately begun to perform various acts of corporate social responsibility and to engage in so-called Socially Responsible Investment (SRI). For evaluators of corporate performance, however, the challenge has been to show whether these social and ethical actions have led to shareholder and stakeholder value. This study is, thus, an empirical attempt at showing whether there is a relationship between “governance-orientedness” and organizational performance, measured by profitability and returns on assets and equity. Exploratory analysis of seventy-two Philippine companies shows that none of the correlations turn out significant, which means that we are unable to conclude anything about the correlation coefficients between the “governance” or “ethics” variables and the financial performance variables. That is to say, there is no evidence, based on the data gathered for this study, that “governance-orientedness” or “ethics-orientedness” is “profitable” or “pays off”. Implications for the development of measures or measurement tools for the social, ethical, and environmental performance of companies are discussed.
I. Introduction
Corporate governance is an area that has grown rapidly in the last few years. There has been an explosion of interest in the corporate and investment sectors and more and more universities are offering corporate governance as a module, either on undergraduate or postgraduate degree programs (Mallin, 2004).
Corporate social responsibility has gained more prominence in recent years along with an emphasis on the company’s board for its responsibility for relations with its stakeholders. More and more, the concept of Socially Responsible Investment (SRI) is being perceived as a mainstream element of good corporate governance; thus, the importance of SRI will continue to gain momentum (Mallin, 2004). An important facet of “ethical investment” is whether there is a beneficial effect on shareholder value, defined at least in the short run by profitability and other financial performance indicators. There have been a number of studies which have looked at the performance of SRI funds but there has been no definitive outcome one way or another as to whether SRI funds outperform non-SRI funds.
The relationship between business corporations’ financial and social performance has been a fruitful area of discussion and study for many years. Some studies provide comprehensive outlines of the many empirical research studies, critiques, and reviews that have examined the relationship between corporate social performance and financial performance (Verschoor, 1998).
This paper explores the relationship between corporate governance —using emphases on ethics and social responsibility as aspects of corporate governance— and financial performance in Philippine companies.
II. Review of Literature
Corporate Governance:
The belief that the primary goal of corporate endeavors should be to maximize value for shareholders still dominates public policy debates. This derives from the “property conception” of the corporation that held sway in U.S. corporate law until the early 1900s. But with the separation of ownership from control, the development of sophisticated securities markets, and the emergence of a class of professional managers who viewed themselves as ‘trustees’ of great institutions, the competing “social entity conception” of the corporation began to take hold. This ‘tug-of-war’ between shareholder wealth maximization and corporate social responsibility has not been completely worked out. Throughout the 1980s, for example, the American Law Institute worked to develop a new consensus statement on principles of corporate governance. The final document stated that the objective of corporations should be “the conduct of business activities with a view to enhancing corporate profit and shareholder gain…Corporations may devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes” (Blair, 1995).
Corporate governance, which is an area that has grown rapidly in the last few years, is important because, among other reasons, it aims to ensure that the company is managed in the best interests of the shareholders and the other stakeholders. In addition, it tries to encourage both transparency and accountability which investors are increasingly looking for in both corporate management and corporate performance (Mallin, 2004).
In a most basic sense, corporate governance “deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment” (Schleifer and Vishny, 1997). In the sense in which the term is being used nowadays, corporate governance “provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined” (OECD Principles of Corporate Governance).
Recent accountability failures in the U.S. and other countries have led to bankruptcies and restatements of financial statements that have harmed countless shareholders, employees, pensioners, and other stakeholders. These failures also created a crisis of investor confidence and caused stock markets around the world to decline by billions of dollars (Walker, 2005). Presumably, it would not be an overstatement to say that the popularity of corporate governance has likewise been brought on by these debacles.
Corporate social responsibility has gained more prominence in recent years along with an emphasis on the company’s board for its responsibility for relations with its stakeholders. A good number of well-known corporations have lately begun to adopt environment-friendly policies and to undertake various forms of corporate philanthropy. These include many, such as ALCOA, Royal Dutch Shell, and Exxon Mobil, which in the past have shown a disdainful disregard for the harm that their operations bring to the environment and to the communities where they operate. Far from being truly altruistic acts, however, these measures are intended to enhance the firms’ corporate image and ultimately to reduce what are called “influence costs”, those that are incurred in dealing with elements of society that are becoming increasingly critical of the way big businesses tend to be indifferent to the needs and concerns of their publics (Poblador, 2006).
The struggle has been, therefore, the creation of value for other stakeholders, while at the same time making enough corporate profit. In any case, the concept of Socially Responsible Investment (SRI) is being perceived as a mainstream element of good corporate governance; thus, the importance of SRI will continue to gain momentum (Mallin, 2004). An important facet of SRI is whether there is a beneficial effect on shareholder value (the value of the investment). There have been a number of studies which have looked at the performance of SRI funds but there has been no definitive outcome one way or another as to whether SRI funds outperform non-SRI funds. Mallin et al. (1995) analyzed the performance of ethical funds and found that on the mean excess returns ethical funds appeared to underperform both non-ethical funds and the market in general, whereas on a risk-adjusted basis, ethical funds outperformed non-ethical funds.
The study by Verschoor (1998) demonstrates a link between overall financial performance and an emphasis on ethics as an aspect of corporate governance: it reveals that the financial performance of those U.S. corporations identified as being committed to ethical behavior or to compliance through codes of conduct ranks higher than that of those companies which do not, using the 1997 Business Week ranking which averages eight publicly-reported measures of historical financial performance.
A study of companies charged with government, financial reporting, or stakeholder fraud or regulatory violation in the U.S. finds that after accusation of fraud, companies increased the proportion of outsider directors on their boards of directors; results, however, show comparable long-run stock price and operating performance between companies charged with fraud and a matching sample of companies not accused of fraud (Marciukaityte, 2006).
Chang (2004), on studying the impact of corporate governance on firms’ financial performance, shows that firm size, scale of borrowing, and proportion of shares held by institutional investors significantly influenced firm performance, as measured by return on equity. Both firm size and increased strength of institutional investors exerted a positive influence on company earnings, while borrowing had a negative effect on earnings.
On the whole, it is widely accepted —especially since the onslaught of the corporate debacles mentioned above— that a corporation’s ultimate success or health can and should be measured not just by the traditional financial bottom line, but also by its social/ethical and environmental performance. This is the underlying rationale of the so-called “Triple Bottom Line” accounting, which purports to measure and report on performance along the social, ethical, and environmental dimensions, in addition to the usual financial measures of performance (Norman and MacDonald, 2004). Some public pension funds in the U.S. have recently been expanding their investment strategy to include environmental protection, sustainability, and good corporate citizenship, giving rise to the contention that companies must emphasize investment criteria that take into account long-term aspects of their operations in terms of their impact on the environment, sustainability, and community welfare (Sethi, 2005).
III. Research Question
This study explores the relationship, if any, between Corporate Governance and financial performance, for a small sample of Philippine companies belonging to the “Financial Intermediation Industry” (Banking, Finance and Holding Institutions). Empirical data are taken from companies’ Annual Reports, with ‘performance’ being represented by financial ratios, and ‘Corporate Governance’ being represented by word or phrase occurrences1 of “governance” or “ethics” via Content Analysis.
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BIBLIOGRAPHY
Blair, Margaret M. (1995), Ownership and Control: Rethinking Corporate Governance, Brookings Institution Press. pp. 202-234.
Chang Aik Leng, Allan (2004), “The Impact of Corporate Governance Practices on Firms' Financial Performance,” ASEAN Economic Bulletin, Vol. 21, No. 3.
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Poblador, Niceto (2006), Strategy Demythicized. Management Association of the Philippines, Makati City, Philippines.
Schleifer, A. & Vishny, R. (1997), “A Survey of Corporate Governance”, Journal of Finance, Vol. 52, No. 2.
Sethi, S. Prakash (2005), “Investing in Socially Responsible Companies is a Must for Public Pension Funds,” Journal of Business Ethics, Vol. 56.
Verschoor, Curtis C. (1998), “A study of the link between a corporation's financial performance and its commitment to ethics,” Journal of Business Ethics, Vol. 17, No. 13.
Walker, David M. (2005), “Reclaiming public trust in the wake of recent corporate account-ability failures,” International Journal of Disclosure and Governance, Vol. 2, No. 3.
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