Good Corporate Governance Mechanism and Firms' Operating and Financial Performance: Insight from the Perspective of Jordanian Industrial Companies

Transcription

1 J. King Saud Univ., Vol. 19, Admin. Sci. (2), pp , Riyadh (1427H./2006) Good Corporate Governance Mechanism and Firms' Operating and Financial Performance: Insight from the Perspective of Jordanian Industrial Companies Assistant Professor of Accounting Department, Faculty of Business Administration, Mutah University, Karak, Jordan Mobile No (Received 8/11/1426H.; accepted for publication 15/4/1427H.) Abstract. Evidence from research conducted analyzed, to establish the association of the factor pertaining to specific corporate practices and structures to firm operating and financial performance indicates an impressing result. The study was based on 39 industrial companies listed in Amman Stock Exchange of Jordan, over the period of 1992 to The study employed two factors of management performance, i.e., operating performance measured by Net Sales to Operating Cost and financial performance measured by Divided Payout Ratio as a model specification in order to test the hypotheses. The full regression statistical result shows that most of the selected variables, i.e., proportion of non-executive directors (BOD), general manager acting dual role as chairman of board of directors (GMCH), GEAR, FIRMSIZE were found, significantly influence the firm operating and financial performance albeit Gearing ratio (GEAR) in the case of financial performance and family members on board (FMOB) with no significant result on firm performance. Finally, the increased strength of proper corporate governance in a firm exert a positive influence on operating performance resulting a better financial performance which ultimately geared up the firm performance. Keywords: Corporate governance, Operating performance, Financial performance, Management performance, Jordan, Jordanian industrial companies. Introduction A good corporate governance is a fundamental necessity to keep on running a firm successfully. Literally, the meaning of corporate governance is the procedures, packed of rules and regulations or a mechanism that controls an organization or a firm in achieving its goals, which is to maximize the long-term benefits of shareholders. But, there are good and bad forms of governance. It also refers to the mechanisms or processes to organize and control a firm to achieve its goals, and to maximize its resources and actions. Van Den Berghe and De Ridder [1] stated that corporate 101

2 102 governance needs to put in place the structures and processes which make it possible for a company to pursue its strategy effectively and hence improve its performance. But, this term is often taken in a narrow and potentially harmful way which cause misled empowerments and finally results in affecting the firms' performance. In many cases, it is considered mostly that the business processes and channeling of information and resources are oversight through committees and auditors only. Cohen and Hanno [2], using the Public Oversight Board's (POB) perspective, defined corporate governance as "those oversight activities undertaken by the board of directors and audit committee to ensure the integrity of the financial reporting process". The criteria of Control Board Guidance on Control (CoCo) of the Canadian Institute of Chartered Accountants [3] focus a broader view of corporate governance by an assurance that an organization achieves its objectives as well as an assessment of the risks that can affect the long-term viability of the firm. Strategies can develop business firm in uncertain and imperfect market conditions and environment. It is an important management task to analyze changing market conditions and environment with a good governance for efficient and perfect long-run benefits of shareholders. At the same time, it does not necessarily follow that the shareholders are the only interest group in the firm. There are many other influential constituents such as lenders, employees, customers, suppliers, competitors, government and society. Good corporate governance essentially develops goals and strategies which are consistent with the interests of these constituents and integrates their actions. It can be done so by a good and proper handling of the firms' operation and by important implications for corporate financial goals and resource commitment. The debate of corporate governance emerged a great profile and of critical interest since the mid-1980's attracting a great deal of attention for the practitioner communities as the managers, shareholders, investors, regulatory agencies, as well as in the academic research. Different countries around the world relatively stimulated by institutional investors have started to assess corporate governance at country or company level, drawing up guidelines and codes of practice to strengthen the issue of governance. However, the role of corporate governance varies and differs across countries and regions. Supranational authorities like the World Bank developed their own set of standard principles and recommendations. This type of self-regulation was chosen above as asset of legal standards [4]. The underlying reason for this emphasis lies in concerns over the integrity of securities markets [5]. In Japan and Germany, it goes beyond protecting the interests of the individual shareholders and investment institutions to developing long-term relationships with various stakeholders [6]. In Asia, corporations tend to follow the insider model, with the dominant control held by the original owners and large shareholders [7, 8]. In Jordan, the initiatives to improve corporate governance had been promoted by launching specific rules and regulations and voluntary improvements in disclosure practice. The government also lay out the task of improving corporate governance at a foremost priority in national agenda. This includes in improving the board structure and disclosure standards. Although the roles and implications of corporate governance differs from one firm to another, or from one country to another, the main important concern is to look forward that the mechanisms

3 Good Corporate Governance Mechanism and 103 impetus a code of good governance which concerns every aspect of an organization and ultimately uplift the organizations performance. Why a Good Corporate Governance is Necessary in the Business Environment Institutional investors have been playing an important role in fostering and enforcing good corporate governance since decades of years. Corporate governance is an integral source of firms' management performance in order to empower the executives. Deminor [9] states that as corporate governance has an impact on the financial risk of their portfolio, it became an integrated part of their investment strategy. The changing business environment have brought public attention to governance processes, with a more emphasis on a good corporate governance. Good corporate governance has long been considered a crucial role for enhancing the long-term value of stakeholders in the business environment. Current business pressures are also forcing executives to adopt rigorous corporate governance with new process orientation for a better return on their investments. At the meantime, companies cannot ignore the pressure for good governance from the shareholder community and market forces. Levitt [10] stated that in new technology driven information age, strong corporate governance is more than good business practice; it is an indispensable component of market discipline. Business environment, thus, demanded rigorously to adopt and implement new corporate rules and regulations purposefully for a continuous better achievement of firm performance. Peter and Behn [11, 12] stress elements that could be contained in a primer on how to run a business. Not at all, even a small company seriously needs a systematic organization, otherwise it can impede the capabilities of the firm performance. An executive alone cannot co-operate with the fast paced and complex world and cannot control every significant decision of a firm. Thus, a firm needs to tap expertise and skilled persons and empower their designation level to contribute all they can within the bounds of a corporate resources and constraints in order to run smoothly and have a successful control. At the same time, emphasis is placed on governing approaches where the citizen is identified in the traditional view as a seeker of benefits and services form governments, but also as a customer and owner of the enterprise. In the modern corporation, the separation of management and ownership of the firm makes a further more complex agent problem with a conflict of interest. The interest of those who manage and control over a firm can differ from the interest of those who own shares and supply external finance. This complex situation can be alleviated through a systematic and good corporate governance. This arises the vigorous needs of a good corporate governance. Meyer [13] says that a systematic governance means adjusting the signals with an organization such that staff automatically do the right things, without the need for oversight. Many studies exist linking good corporate governance with better performance. Coles et al., Durnev and Han [14, 15] found that companies with better corporate governance enjoy higher valuation. These studies' results, which help in confirming the idea of good corporate governance, result in better decisions at all levels of the

4 104 organization, not at top-management and board levels, but also in the better performance of the organization. Newell and Wilson [16] studied six emerging markets and predict, on average, an increase of 10 to 12% in market value if companies are moving from worst to best in corporate governance. Klapper and Love [17] also found a positive correlation between good governance and market valuation. However, few studies make the explicit missing link between good corporate governance and better performance. From this above discussion, it can be concluded that the issue of good corporate governance and firms performance is still open for discussion and requires further research. Thus, this study is a genuine attempt to fill this void and to add more literature. In order to fulfill this purpose, the rest of the paper is presented as follows: the following section contains a brief theoretical background of Jordan firms and the depiction of the methods and procedures used for this empirical study and the development of the hypotheses to be tested. The third section describes the methodology and the sample employed in this study. The next section explains the analysis and interpretation of the study and finally the fifth and the last section present summary, conclusions and the guidelines for further studies. Background and Hypotheses Development Firm management performance is indeed a complex issue. Performance is finally the outcome of many inter-linking factors where corporate governance is only one possible element within the whole set of performance drivers [18]. Relatively, examining the impact and role of corporate governance in firms' operating and financial performance is indeed a complicated study, which can result with a controversial idea. At the same time, Deminor [9] expressed that installing a proper corporate governance mechanism provides the company with a competitive advantage in attracting the capital, reducing the financial risks for investors and consequently, the cost of the capital. Various contractual mechanisms, including corporate governance, are designed to monitor managements behavior. According to the agency theory, the members of the board, who are performing the monitoring function, should be independent of those being monitored, i.e., the management. The board's focuses are expected to be directed primarily toward monitoring and control, evaluation of corporate performance, global risk management recruiting, and compensation. Dalton et al. [19] argued that agency theory is the theoretical basis of most of the research on corporate governance, they suggest the need to consider other theoretical ways of examining the relationship and propose a substitution theory approach which considers a range of governance mechanisms. There is a growing argument that corporate governance should encompass not only the interests of shareholders, but also other stakeholders such as employees, customers, suppliers, and the community. However, the policy and legal framework to realize this need are yet to be developed [20]. The main objectives of this study are to briefly discuss the current state of corporate practices of firms in Jordan, and to establish corporate governance factors that significantly influence the operating and financial performance of Jordan firms. Another

5 Good Corporate Governance Mechanism and 105 related purpose is to make an approach for the measurement of good governance at the functional level of an organization. This study describes a radically different approach focusing the need of a good corporate governance in Jordan. Corporate governance characteristics albeit playing different roles in ensuring companies success are ultimately the only responsible role affecting the firms' management performance. Jordan is thought to be of interest not only because it is a developing country with an emerging capital market, but also enjoys a capitalist democratic system which is ruled by individuals themselves. The drastic ups and downs shift in its economic strategy and policies at the capital markets and trade led a dearth need of rigorously established knowledge on corporate governance. Jordan, furthermore, suffered a shortage of experienced financial and manpower resources and lack of legal procedures for financial disclosure. This means that this issue should be addressed thematically. Moreover, this paper will enhance a more deeply understanding influence of the corporate governance mechanisms, while controlling for firm-specific factors. Furthermore, the findings may lead to certain opinions relevant to the research conducted in this area and to add at the literature for future researchers. The following is a separate discussion for each variable relating the development of the hypotheses. (i) Board of Directors (BOD) Board of Directors is defined as "the proportion of outside directors to the total number of directors (Shamser and Annuar [21]), thereby making a distinction between executive and non-executive (outside) directors. The board of directors is a principal mechanism that can enhance and create the coalitions with the stakeholders controlling resources required by a firm [22]. They are responsible for the truthfulness and fairness of company accounts. They also support the company by facilitating the acquisition of needed resources. Albeit this responsibility, they do not actively participate in helping the firm cope up with environmental uncertainties or gives direction and vision to the firms' business. Here, two views can be discussed, i.e., those who favor more nonexecutive members in the board of directors and those who prefer more executive members in the board of directors. Many studies are found discussing these two views and most of the results are found favoring the views that companies with relatively more independent directors tend to be more profitable than those with fewer independent directors. Fama and Jensen [23] lay that outside directors might be considered to be decision experts independent and not intimidated by the chief executive officer. Dehaene et al. and Pearce and Zahra [24, 25] also suggest that firms with a higher proportion of outsiders on the board of directors are associated with better performance. This can be a reason that the higher the proportion of non-executive directors, the board is more independent in making decisions which ultimately affect the firm s operating and financial performance. Contrary to this result and view, Bhagat and Black [26] proposed that a high proportion of independent directors is strongly correlated with slower past growth across a number of accounting variables, but not so with future performance. Klein [27] also shows a high proportion of independent directors correlates with lower past profitability, whereas Mallete and Fowler [28] and Molz [29] show a result of no significant relationship between the independence of the board and firm management performance.

6 106 At the same time, the commitment of the board of directors to a firm will decrease if a member indulges more than a company concurrently, but Stanwick and Stanwick [30] found inverse relationships between the cumulative number of boards and the members of the board of directors belong to and firm performance. This might be a reason that indulging to more firms helps in gathering valuable information for any specific firm and increase their experience in practices. Thus, the results of previous studies relating the impact of the board of directors on firm performance have been reported as mixed result. The board of directors as a mechanism of a firm is considered to be an interesting variable measuring the corporate governance relative to the firms' operating and financial performance. This variable would help in showing the operating and financial performance system by carrying out their monitoring role, which will impact the firms' management performance. In the case of Jordan, the management of a company, either private or public shareholding company, is entrusted to a board of directors whose members shall not be less than three and not more than 13 as determined by the company's Memorandum of Association, provided in the Companies Law number 22 of The board of directors will undertake the management for four years from the date of its election. According to the Company Law of Jordan, private shareholding company's board of directors members may not be members of other companies' board of directors, unless with similar objectives or a competitive business with the consent of the company's extraordinary General Assembly, whereas, in the public shareholding company's, a person can be entitled to be a member of a board of a maximum of three public shareholding companies concurrently. Based on these above ideas and discussion, the researcher proposed the following hypothesis to be tested: H 1 : The higher the proportion of non-executive directors, the better the operating and financial performance of the firm. (ii) Family Member on Board (FMOB) The proportion of representation in the family on board can also enhance a great deal in the operating and performance system of a firm as much as non-executive directors on boards do. It may be considered that a greater family members on board can support the company more actively by facilitating the needed resources, which can increase and affect the firm performance. At the same time, there can be also a negative notion that the higher the family members, the lesser internal information disclose. Nicholls and Ahmed [31] say that in countries where families have substantial equity holdings, there is generally a little physical separation between those who own and those who manage the capital. Adhikari and Tondkar [32] furthermore extend the view that capital owners do not have to rely extensively on public disclosure to monitor their investments, since they have greater access of internal information. In the case of Jordan, there are a number of companies at the selected list of companies who elect their family

7 Good Corporate Governance Mechanism and 107 members to sit on the boards, both as executive and non-executive directors. As such, this may be expected in helping the firm to cope up with the outside environment as well as inside operating system which can ultimately result to improve the firms' management performance. So relatively, to test this above notion, the researcher formulated the following hypothesis: H 2 : The higher the proportion of the family members sitting on the board, the better the operating and financial performance of the firm. (iii) Chairman of the Audit Committee (COAC) Audit committee is one of an important mechanism for corporate governance. This variable is taken in order to test the degree of independence of the audit committee on the operating and financial performance of a firm. The role of an audit committee members has been studied in various aspects, such as independent members, composition, expertise, disclosure of activities, and quality of financial reporting [33, 34]. An audit committee plays an important role in influencing on financial reporting. The audit committee can strengthen the roles of both internal and external auditors in corporate governance. Blue Ribbon Committee Report defines the audit committee as the "ultimate monitor" of the financial accounting reporting system [35]. It furthermore comments that audit committees must now meet a number of requirements that more clearly define their objectives as well as the composition of the committee. But at present, a question arises that whether the audit committee maintained its independence to oversee financial managements and in reporting responsibilities. In most of the major companies, the board of directors selects the audit committees and fix their renumeration. Thus, in practice, the auditors are reluctant to comment on the directors fearing that this added responsibility will add to their liabilities. The chairperson of an audit committee also acts an important role in improving board effectiveness. Dezoort et al. [36] found in their study that a number of independent audit committees is associated with reduced risk of financial reporting, and higher fees paid to the external auditors. They also found that more frequent meetings of the audit committee could reduce financial problems including fraud. Studies done by Rechner and Dalton, and Donaldson and Davis [37, 38] also support that independent nonexecutive chairpersons improve company performance. Carcello and Neal [39] lay that audit committee members who are independent of the management are better monitors of the firms' financial accounting process. However, Chaganti et al. [40] found that executive chairpersons have no effect on the performance. As far as Jordan is concerned, the General Assembly of a Public Shareholding Company, a limited partnership in shares, a limited liability company and a private shareholding company shall elect one or more licensed auditors for a one renewable year [41]. Therefore, it may be expected to have more improve firm performance due to their independence. And in general notion, it is expected that a more independent chairperson

8 108 of the audit committee can undertake more effective monitoring, which ultimately can result in the improvement of the firms' operating and financial performance. Thus, resulting from these above reviews, the researcher postulate the following hypothesis to be tested: H 3 : There is a positive association between a non-executive chairperson and the extent of firms' operating and financial performance. (iv) The General Manager Role Duality (GMCH) This variable is chosen in order to measure the degree of operating structure and financial performance of a firm, when the General Manager is also acts as the Chairman of the Board of Directors. Role duality exists when a firm executive manager is also acts as the Chairman of the Board of Directors. This duality structure can affect the operating and financial performance of the firm as the General Manager as well as the acting Chairman of the Board of Directors that has the power to control the board meetings, select agenda items and as well as selecting the board members. Lots of studies had been found relating this area. Some of the studies were found having a positive association with duality structure of the general manager and firm performance, and others found a negative association; whereas some of the studies result in having no relation with duality structure of the executive manager. Studies done by Donaldson and Davis, and Dahya et al. [38, 42] examined the effect of the duality role of a general manager (Chief Executive Officer - CEO) on operating and financial performance. They found that managers act in the best interests of the firm and shareholders returns. Furthermore, when the executive manager acts as a dual role, the manager may be more free to mould the companies' stated objective to be achieved, hence results in the improvement of the firms' management performance. On the one hand, Rechner and Dalton, and Blackburn [37, 43] argued this notion saying that companies which have CEOs performing dual roles do have lower shareholder returns as the executive managers' ability to distort the financial statements and are also considered as opportunistic shirkers. On the other hand, studies done by Boyd [44] conclude that duality in the role of the executive director can have a positive effect on firm performance under certain industrial conditions like resource scarcity or high complexity, and have a negative effect under other conditions. In reference to this present study, around 25% of the selected listed industrial companies of Jordan have role duality. Thus, this variable is considered worthy to be tested. Hence, from this above discussion of the related reviews, the researcher, in order to testify whether the role duality enhance a positive or a negative operating and financial performance measured by net sales to operating cost and dividend payout ratio respectively, postulates the following hypothesis for an empirical test:

9 Good Corporate Governance Mechanism and 109 H 4 : There is a positive association with firms' operating and financial performance if the general manager acts a dual role than if the general manager does not. (v) Gear This variable plays a significant role in corporate governance. It fulfills the important corporate governance role for stakeholders. It is considered to be worth taking in order to study the degree of relationship between the amount of money that a company owes and the value of its shares. Belkaoui and Kahl; Wallace et al., and Malone et al. [45-47] also suggest that gearing has been found to be an important explanatory variable. Shareholders are investing their money in the shares of a company in the expectation of return on their invested capital. However, sometimes managers' manipulate earnings to delay or avoid debt covenant violations. Defond and Jiambalvo [48] say that managers overstate earnings in the year before debt covenant violations. The impact of the gearing ratio (GEAR) on the operating and financial performance is still vague. One way is that the higher the gearing ratio, it can save taxes, since interest is a deductible expense. On the other hand, it can cause financial distress, which then becomes an obstacle or limits the ability of the firm to take more risky projects, and then ultimately leads a huge impact to the firm operating and financial performance. This variable is defined as the total amount of debt owed by the company, divided by its total capital, where the total capital is equivalent to shareholders ordinary funds plus long-term debts. Thus, in order to testify this argument, the researcher postulates the following hypothesis: H 5 : Higher gearing ratio has a positive association with the operating and financial performance of the firm. (vi) Firm size This variable is considered worthy to take as it denotes the size of the company in terms of total assets. It may also show the level of internal operating system and how far the current knowledge contributes to corporate governance practice, and its impact to the firms' operating and financial performance. Firm size has been found to be a significant variable in many previous research studies. O'Reilly et al. [49] contribute that larger firms have stronger internal control systems than smaller firms. At the same time, larger firms are expected to have more fraudulent financial statements. Buzby [50] says that larger firms have more complexity of the business structure than smaller firms. This will lead the larger firm to a closer monitoring by regulatory authorities and by adopting stronger monitoring mechanisms, which will ultimately have an impact on corporate governance. Thus, the following hypothesis is formulated for an empirical test:

10 110 H 6 : The larger the firm size, the more stronger corporate governance, which have a positive impact on firms' operating and financial performance. Research Methodology This section on research methodology explains the data and the sources of data, methods used in the analysis of data and the constructions of the research model to test the hypotheses. Data and sources of data For an indepth analysis of the proposed hypotheses, the researcher employed initially all the 89 industrial companies listed in the Amman Stock Exchange (ASE) over the period The researcher, for its feasibility and to maintain an accuracy with a satisfactory result, has selected only the manufacturing large scale industrial companies. The companies were selected using a purposive sampling. The sample firms were industrial companies quoted either in the first, second or third market listed in the Amman Stock Exchange. The majority of the selected companies (72%) came from the first market. After a careful scrutiny of the availability of data for all the variables, out of 89 total industrial companies, 21 companies were eliminated because of having incomplete information on the variables needed for the study, 12 companies were under liquidation and 17 companies were established on or after the period under study. Thus, finally, the sample of the study consisted of 39 industrial companies. Corporate governance data were gathered from the annual reports published by the selected industrial companies, Jordanian shareholding companies guide, and other relevant data. The data which were unavailable in the aforementioned sources were taken from the Website of Amman Stock Exchange. The researcher personally collected all the sources of the data. Methods of analysis The purpose of this paper is to measure the corporate governance and how the mechanism of the corporate governance control the operational structure and corporate performance and its impacts to firm management performance. Therefore, the measurement of firm performance is primarily comprised of two factors: operating and financial performance. Financial performance is at the core of the organizational effectiveness domain (Chakravarthy [51]), while operating performance measures such as quality and market share define a broader conceptualization of firm performance by focusing on factors that ultimately lead to financial performance [52, 53]. Many researchers used different ways of measurement to measure the financial performance. Some used Return on Assets (ROA), Return on Sales (ROS), and some used Return on Investment (ROI), an accounting measure widely regarded as the "bottom line" test of business performance despite occasional criticism. In this study, as the main focus is on measuring the mechanism of corporate governance to firm

11 Good Corporate Governance Mechanism and 111 management performance, the researcher select the dividend payout ratio, i.e., the dividend declared and paid to shareholders for the year, as the most suited ratio to be used. This will help in showing the proportion of earnings and paid out as dividend for firm specific. Relating the measurement of operating performance, some scholars used effectiveness and efficiency, some adopted net sales divided by operating cost as measurement [54], some used the company's market value to evaluate performance, while some also used Tobin's Q for judgment [55]. Hence, in this study the researcher used (NS/OC) to measure the operating performance. Thus, for an indepth analysis, the researcher based on two dependent variables to measure the firms' management performance, i.e.: (i) Operating performance, and (ii) Financial Performance. The operating performance was defined as Net Sales to Operating Cost (NS/OC), and financial performance measured by dividend payout ratio is defined as the percentage of the dividend declared and paid to shareholders for the year. This two dependent variables were factors that can influence the firms' management performance. Multiple regression is extensively used to assess the extent to which variability in the extent of operating and financial performance explained by the various corporate governances. The study also used correlation matrix to identify the association between the firms' management performance and the chosen variables. Furthermore, the nonparametric/distribution free techniques of statistical analysis are also employed exclusively to emphasize the mean and standard deviation. Construction of model Based on the above discussion, the researcher, in order to see the association between the corporation governance in operating and financial performance, constructs the following regression models: Model 1: Using Net Sales to Operating Cost (NS/OC) as a dependent variable: NS/OC = α + β1( BOD) + β 2 ( FMOB) + β ( COAC) + β ( GMCH ) + β ( GEAR) β FIRMSIZE + 6 ( ) λ Model 2: Using Dividend Payout Ratio as a dependent variable: DIVPAY = α + β1 BOD + β 2 FMOB + β 3 COAC + β 4 GMCH + β5 GEAR + β FIRMSIZE + 6 ( ) ( ) ( ) ( ) ( ) ( ) λ

12 112 Definitions of the abbreviations are as follows: NS/OC: to measure the parental firms' operating performance, with net sales by operating cost. DIVPAY: to measure the parental firms' financial performance, with dividend declared and paid to shareholders for the year. α: is the constant term. β: the coefficients of the regression equation. BOD: the proportion of outside directors to the total number of directors. FMOB: represent family member on board. GMCH: represent the general manager also acting as the chairman of the board of directors. GEAR: the total amount owed by the company divided by its total capital. FIRMSIZE: the size of the firm used as logarithm, in terms of total assets. λ: is the disturbance terms. Analysis and interpretation of data This section on analysis and interpretation shows and explains the Descriptive Statistics Analysis, Pearson Correlations Coefficients Matrix among the dependent and the explanatory variables, and the formal final hypotheses test is based on multiple regression analysis of the data. A delimitation of this study is that the variable Chairman of the Audit Committee (COAC) is deleted from the statistical analysis. This variable as a binary variable takes the value of one, if the Chairman of the Audit Committee is a non-executive director, otherwise the variable assumes a value of zero. All the selected industrial companies of Jordan appoints their chairman of the audit committee outside the executive members, which results in equally having the same value of one. Thus, the result of the statistical analysis may be bias with this variable and hence omitted. Table 1. Descriptive statistics among the dependent and explanatory variables for a pooled sample of 39 industrial firms years 1992 to 2004 Minimum Maximum Mean Std. deviation NS/OC DIVPAY BOD FMOB GMCH GEAR FIRMSIZE NS/OC: to measure the parental firms' operating performance, with net sales by operating cost as dependent variable; DIVPAY: to measure the parental firms' financial performance, with dividend declared and paid to shareholders for the year as dependent variable; BOD: the proportion of outside directors to the total number of directors as an independent variable; FMOB: represent family member on board as an independent variable; GMCH: represent the general manager also acting as the chairman of the board of directors as an independent variable; GEAR: the total amount owed by the company divided by its total capital as an independent variable; FIRMSIZE: the size of the firm used as logarithm, in terms of total assets as an independent variable.

13 Good Corporate Governance Mechanism and 113 The above table presents the result of the descriptive statistics analysis between the dependent variables and the independent variables by measuring the mean, the standard deviation and the percentage of distribution range of the pooled years of the sample under study. From the above table, the dependent variable Net Sales/Operating Cost (NS/OC), is found with an aggregate mean and standard deviation of 10.69% and 7.21% respectively and with the range from 0.50% per cent to 47.57%. Dividend payout ratio (DIVPAY), as a dependent variable, is also found with an aggregate mean and standard deviation of 37.59% and 42.51% respectively and the range is from zero to %. All the independent variables also show a normal score distribution. Thus, in general, this table shows a normal distribution score of the dependent and independent variables. Table 2. Pearson Correlation Coefficients Matrix among the dependent and explanaotry variables for a pooled sample of 39 industrial firms - years 1992 to 2004 NS/OC NS/OC DIVPAY BOD FMOB GMCH GEAR FIRMSIZE DIVPAY BOD 0.412(**) 0.256(**) FMOB (**) GMCH 0.358(**) 0.294(**) 0.424(**) 0.291(**) GEAR 0.286(**) (*) FIRMSIZE 0.438(**) 0.396(**) (**) (**) 0.468(**) * Correlation is significant at the 0.05 level (2-tailed). ** Correlation is significant at the 0.01 level (2-tailed). Table 2 summarizes the Pearson Correlation between the transformed dependent and independent variables for the pooled sample under study. The result of the table supports almost all the hypotheses. The table shows a positive significant correlation at 0.01 level between the dependent variable, i.e., operating performance measured by Net Sales by Operating Cost (NS/OC), with all the variables, i.e., Board of Directors (BOD), General Manager with role duality (GMCH), Gearing Ratio (GEAR) and FIRMSIZE albeit with family members on Board (FMOB) with no significant relation. (FMOB) and (GEAR) are found having negative correlation with financial performance, whereas (BOD), (GMCH) and FIRMSIZE are found having a positive correlation with (DIVPAY), where (BOD), (GMCH) and (FIRMSIZE) are also found positively significant at 0.01 level. Thus, it shows a significant variable influence with a high operating performance, in the case of the more proportion of non-executive directors and duality performance of the General Manager who also acts as the Chairman of the Board of Directors, which in return geared up the financial performance. The result on gearing ratio (GEAR) shows that firms with relatively high debts with respect

14 114 to shareholder capital funds, have statistically significant better operating performance, whereas in the case of financial performance, it is found with just the opposite result. As far as FIRMSIZE is concerned, the result shows a better operating and financial performance, with excessive firm size. The table also reveals that many explanatory variables are significantly correlated with each other. In general, this result indicates a supporting result to the formulated hypotheses of the study. Thus, in order to support a more concrete result, and indepth exploration of association between the dependent and independent variables, the study furthermore, estimates the regression analysis, in which the hypotheses tests are formally based on. Table 3. Results of regression analysis using the operating performance as the dependent variable for a pooled sample of 39 industrial firms years 1992 to 2004 (Model 1 NS/OC) Variables Hypothesis number Estimated coefficient Standard error Beta t-statistic Significant Constant BOD FMOB N.S. GMCH GEAR FIRMSIZE R² Adjusted R² F-test & (Sig.) (0.000) N.S.: Not Significant. NS/OC: to measure the parental firms' operating performance, with net sales by operating cost as dependent variable; BOD: the proportion of outside directors to the total number of directors as an independent variable; FMOB: represent family member on board as an independent variable; GMCH: represent the general manager also acting as the chairman of the board of directors as an independent variable; GEAR: the total amount owed by the company divided by its total capital as an independent variable; FIRMSIZE: the size of the firm used as logarithm, in terms of total assets as an independent variable. Table 3 summarizes the regression equation result using normal scores for the variables. The regression measuring the operating performance by Net Sales to Operating Performance (NS/OC) produced R Square with and adjusted R Square with In general, the model fits the data as shown by the R² and F statistics. The regression equation shows a very significant result confirming and favoring the results of the earlier correlation analysis.

15 Good Corporate Governance Mechanism and 115 From the above table, it shows that almost all the variables, i.e., BOD, GMCH, GEAR, and FIRMSIZE albeit FMOB, were found to be statistically significant influencing operating performance. A possible explanation of this result might be because of companies with relatively more independent directors are more carefree and independent in making the right proper decisions without any influence by the chief executive officer. This result supports the study of Fama & Jensen [23], Dehaene et al. [24], and Pearce & Zahra [25]. They also see the role of non-executive directors as monitors of management s performance. Mangel & Singh [56] believe that nonexecutive directors have more opportunity for control and face a complex web of incentives, stemming directly from their responsibilities as directors and augmented by their equity position. In addition to this control aspect, they also act as an advisory providing an extra link-up with the outer environment due to their high effective experience business knowledge. Thus, non-executive directors are seen as the chief and balance mechanism in enhancing the board s effectiveness, resulting in better operating performance. This ultimately influences the financial performance and geared up a positive impact to the firms' management performance. Therefore, this result is found consistent with the hypotheses of the study. Similarly, the chief executive officer or the general manager having a dual role as the chairman of the board of directors also shows a highly positive impact on the firm operating performance. One reason may be that the managers are persistent in monitoring the firms decisions or may be they are devoted strictly in their best interest to mould the company s aims and objectives which definitely helps in improving the firms performance. This finding is found to have a favoring result with the studies done by Donaldson and Davis [38], and Dahya et al. [42]. Thus, this mechanism of corporate governance is found to be an influencing factor in shaping and moulding the firm performance and therefore is found consistent with the postulated hypotheses. With respect to GEAR or Borrowing and FIRMSIZE, these variables show an impressing drastic impact to firm performance. The result is found consistent with the hypotheses postulated, favoring that higher debt ratio and larger firm size have a positive impact to the firms operating performance. A reason for higher gearing may be the higher the stakeholder invested to a firm, they vested more interest and get more involved in the firms decisions. Furthermore, their interest is no more in the returns of equity but also in the strategies of the firm. This results an incentive tendency to monitor the behavior of managers and other relative authorities in the operating performance of the firm, which after all influence a positive operating performance. At the same time, the larger the size of a firm, the business structure becomes more difficult and complex, which needs to inoculate themselves a stronger internal control of corporate governance system. This results in forming an assertive stronger regulatory authorities for a closer monitoring of the firms operating performance. The variable FMOB shows an insignificant coefficient indicating insignificant effect on the operating performance. This means that FMOB is not an impressing mechanism of corporate governance influencing the firm as far as operating performance

16 116 is concerned. In general, this table indicates an impressive supporting result conforming the postulated hypotheses of the study and the original expectation of the research. Table 4 shows the regression equation results using normal scores of financial performance for the dependent variable dividend payout ratio (DIVPAY), with the other independent variables. The regression equation shows an R Square of and adjusted R² of This shows that the model fits the data. The table shows a significant consistent result favoring the former tables. Table 4. Results of regression analysis using the financial performance as the dependent variable for a pooled sample of 39 industrial firms years 1992 to 2004 (Model 2 DIVPAY) Variables Hypothesis Estimated Standard t-statistic Significant Beta number coefficient error Constant BOD FMOB N.S. GMCH GEAR N.S. SIZE R² Adjusted R² F-test & (Sig.) (0.000) N.S.: Not significant. DIVPAY: to measure the parental firms financial performance, with Dividend declared and paid to shareholders for theyear as dependent variable; BOD: the proportion of outside directors to the total number of directors as an independent variable; FMOB: represent family member on board as an independent variable; GMCH: represent the general manager also acting as the chairman of theboard of directors as an independent variable; GEAR: the total amount owed by the company divided byits total capital as an independent variable; FIRMSIZE: the size of the firm used as logarithm, in terms of total assets as an independent variable. The above table shows a relatively positive significant result with most of the variables, i.e., BOD, GMCH and FIRMSIZE. This means that a better operating performance does have a positive effect to the financial performance of the firm. The BOD, GMCH and FIRMSIZE as a mechanism of corporate governance have a positive influence penetrating and improving the development of the operating performance which ultimately results in generating a positive and strengthening the effect on the financial performance also. As far as GEAR is concerned, a statistically insignificant influence is found influencing the financial performance. This phenomenon may be because of higher debt ratio not only increases a higher financial risk but also escalates the cost of financial spending, which limits the ability of the firm to take more risky projects, decreasing the firms financial performance. At the same time, FMOB as a mechanism does not have any significant effect to the firms financial performance. Therefore, this table also gives an impressive support of the former tables, confirming the original expectation of the research.

17 Good Corporate Governance Mechanism and 117 Conclusion This study attempted to establish the relationship of the factors pertaining to corporate governance and its effect to the firm operating and financial performance using a sample of 39 industrial companies that represent the major economic sector of Jordan, over the period of The study employed two-model specification in order to test the hypotheses, using two factors, i.e., operating performance measured by Net Sales by Operating Cost (NS/OC), and financial performance measured by Dividend Payout Ratio (DIVPAY). The result based on the full regression model of the sample indicating operating performance shows an impressing significant impact with the chosen variables. The mechanism of corporate governance, i.e., the proportion of non-executive directors in the company (BOD), the role of the Chief Executive Officer (CEO) as both the General Manager and Chairman of the Board of Directors, the Gearing Ratio (GEAR) or the level of debts and FIRMSIZE of the company are all found statistically significant, favoring the postulated hypotheses albeit Family Members on Board (FMOB). Thus, it shows that FMOB as a mechanism does not have any significant association with both the dependent variables of the study. Regarding the significant corporate governance mechanism affecting the financial performance, the results also show a significant consistent result with the postulated hypotheses. The selected corporate mechanism, i.e., BOD, GMCH and FIRMSIZE led to penetrate a higher chance in improving financial performance. This implies that the outside directors stimulate in helping as a bridge by communicating with the outside environment, providing important and useful information and also at the same time they are more reliable and balanced in enhancing proper decision making of the firm. Similarly, GMCH and FIRMSIZE do also generate a positive effect on the operating performance which ultimately strengthen the financial performance. Gearing ratio as a factor of cooperate governance shows an enhancing influence at the operational level, but it is just the opposite as far as financial performance is concerned. This may be due to high debt not only increases the financial risk, but also escalates the cost of taking big projects, and decreasing the firms' financial performance. In general, the results of this study include significant findings and are found consistent with many of the former studies. It also might help the firm executive members to be focused on better management performance by giving more attention to those mechanisms which enhance positive effects to the management performance. This will also ensure the companies that a systematic and good corporate governance will enhance a more reliable effect on the firm performance. This implies that the Jordanian industrial companies should consider and undertake these policies to promote attraction to more domestic and foreign investment. At the same time, cautions should be made of this papers' delimitations. This study centered to five mechanisms of corporate

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