The Efficacy Impact of Corporate Governance Compliance on the Financial Performance of Cooperative

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1 Available Online at Book of Proceedings published by (c) International Organization for Research and Development IORD ISSN: Book of Proceedings ISBN: IRC-2015 Istanbul-Turkey. The Efficacy Impact of Corporate Governance Compliance on the Financial Performance of Cooperative Zelhuda Shamsuddin a a Faculty of Business Management and Accountancy Universiti Sultan Zainal Abidin (UNISZA) Kuala Terengganu, Malaysia and Institut Islam Hadhari, Universiti Kebangsaan Malaysia, zelhuda@gmail.com Bangi, Selangor, Malaysia Abstract This paper empirically investigates the relationship between the efficacy of corporate governance compliance assessment score and cooperative financial performance with special focus on governance mechanism implemented by regulator which consists of monitoring and supervision attributes. One would expect the monitoring and supervision function would promote financial performance of cooperative organization. One would also expect that it would not influence the financial performance of cooperative organization. However, with increasing numbers of cooperative in Malaysia, we consider our aim is important to control and avoid governance failures in cooperative environment. Using a panel data of 100 listed best cooperative for the period of and return on asset (ROA) and return on equity (ROE) as proxy to cooperative financial performance, we find a negative impact of corporate governance compliance assessment and cooperative performance. This paper provides the first study in Malaysia cooperative in providing empirical evidence using econometric model on specific corporate governance compliance assessment that was not explored before. This paper is proceeds as follows. We consider here first the previous literature on the efficacy of corporate governance compliance and performance. We continue to explain related hypothesis to this study, data sources and model development. Finally, we present empirical results and discuss their implication European Journal of Research on Education by IASSR. Keywords: cooperative, corporate governance, financial peformance, panel data 1. Introduction The importance need of strong corporate governance, better internal and external controls, in a way to improve governance arrangement, financial transparency, has imposed governments and regulatory bodies to issue new strict law, regulations and corporate governance code to promotes corporate accountability and corporate behavior. However, an effort to reform corporate governance system in Malaysia cooperatives organization is not overwhelming as corporate governance system in Malaysia public listed companies. As the importance of cooperative organization in delivering product and services has grown, they have come under increased in government scrutiny. The significant contribution of cooperatives firms in Malaysia emerging economy is obviously accepted and is more important than ever before. The cooperatives movement continuous to grow to cooperatives in 2013 compared to 7215 cooperatives in Malaysian cooperative includes variety of industry distribution which includes banking, credits, consumer, agriculture, housing, transportation, industrial, and service.

2 2 Z.Shamsuddin The Malaysian government introducing the first cooperative policy to map the direction of cooperatives in Malaysia known as the National Cooperative Policy ( ). This policy also introduced a supporting government institution namely the Commission of Co-operative Malaysia (Suruhanjaya Koperasi Malaysia (SKM)) that provides financial support, business development, legislative updates, and regulatory control under Ministry of Domestic Trade, Co-operatives and Consumerism.Cooperatives are registered under the Co-operative Societies Act 1993 which stated on the procedures of the registration, right, rules and regulation related to cooperatives. However, there were cooperatives facing bad management practices either because of conflict of interest among board members or failed to meet the SKM regulations.skm has introduced a corporate governance reform to cooperatives, which include the compliance assessment representing of corporate governance weightage. The compliance assessment contains a governance checklist attributes for cooperatives to follow. Therefore, the corporate governance compliance assessment represent as a monitoring and controlling function by SKM to evaluate the corporate governance compliance of cooperatives. The corporate governance compliance assessment score represent seventeen score from the total of non financial evaluation score to determine the 100 best cooperative for a particular year. This corporate governance compliance assessment would encourage for better resilience in cooperative governance and management to be transparent among its members, and promote better financial performance. Good corporate governance influence to improve financial performance (Black et al., 2009) and improve manager investment decision (Shleifer and Vishny, 1997). The main objectives this of study is to find out the efficacy of the current practice corporate governance compliance assessment implemented by SKM to cooperative financial performance i.e. by finding out the relationship between the corporate governance score and financial performance. The firm performance is measured using accounting ratio (financial performance). 2. Literature Review There has been little presence of corporate governance literature in the cooperatives environment. Corporate governance principles can be applied to all the firms. However, an emphasize of corporate governance has been dominant issue in most of organization and no exception to cooperatives. The first theoretical of corporate governance can be found in the work of Berle and Means, (1932) in their book, The Modern Corporation and Private Property, asserts that shareholders are the legal owner of corporation, and the managerial duty was given authority to manage the corporation with fiduciary responsibility. The personal separation of owners and managers, and the legal separation of ownership and control thus lead a creation of nexus of contracts within the parties in the organization. In addition, this led to the development of types of contracts that suit the agency relationships. Agency theory model by Jensen and Meckling (1976) applies to relationships in which one party (the principal) delegates the responsibility to manage the corporation to another person (the agent). However, problems could exist between them in terms of conflicting goals, different attitude toward risk, information asymmetry, incompleteness of contract and moral hazard problems and it is difficult and expensive for the manager to monitor the agent activities. The assumption of an absence of separation between ownership and control, it can be posited that agency theory is a significant in firm discipline but little attention has been devoted to cooperatives in the corporate governance mechanism. However, it cannot be assumed that there is no separation of ownership and control in cooperative, especially when the number of members of the cooperatives increases. Hence, when cooperative organization become larger, grew in its members, wider in its operation and investment, the agency conflict may emerge from the management, engaged workers or professional managers. Basically, the corporate governance structure specifies the right distribution, responsibilities, relationship between owner and manager, and the internal and external control mechanism to monitor the management behavior in making decision on corporate affair. However, corporate governance principles can be applied to all organization because it specifies the right distribution, responsibilities, relationship between owner and manager, and the internal and external control mechanism to monitor the management behavior in making decision on corporate affair. The importance of good corporate governance has been dominant issue in most of organization. Therefore, we can say that importance of corporate governance is the same to investor-owned firms (public listed company) and cooperative organization. There exists empirical evidence that good corporate governance can lead or improved financial performance, better investment decision by management (Shleifer and Vishny, 1997) and distributed free cash flow to shareholders (La Porta et al., 2002). Bhagat and Bolton (2008) conducted empirical studies to test the

3 The efficacy impact of corporate governance compliance on the financial performance of cooperative relationship between the corporate governance, corporate structure and ownership structure and firm performance. Their result found corporate governance is significantly positively correlated to firm performance. Renders et al., (2010) also reported significant positive relationship impact between corporate governance ratings and firm performance. Recently, an evolvement study in relation to code compliance and firm performance explicit an evidence of code compliance positively impact to firm performance (Tariq and Abbas, 2013). Tariq and Abbas (2013) provide empirical evidence on efficacy of the rule-based Code of Corporate Governance compliance and firm performance using a panel data of non-financial data of 119 Pakistani firms for 8 years period. More significantly, their study has reported a positive impact of compliance on firm s performance Hypothesis Development Based on the findings of the above reviewed studies, the hypothesis for this study is as follow. H 1 : There is a positive relationship of efficacy of corporate governance compliance assessment and cooperative financial performance. 3. Methodology 3.1 Sample and data The financial data and efficacy of corporate governance compliance assessment score relating to this study were obtained from Statistic Coordination Division, SKM. The sample consists of hundred best cooperative over Table 1 reports the industry wise distribution of sample cooperative used in this study. Panel Data Regression is used to estimate the model of this study. Table 1: Industry-wise distribution of hundred best cooperative in Industry Number of cooperatives Banking Credits Agriculture Housing Consumer Construction 1 1 Transportation Services The efficacy of corporate governance compliance assessment score We define corporate governance practices using the corporate governance compliance assessment score done by SKM to cooperative that act as monitoring and controlling functions of SKM as a regulator to cooperative. The corporate governance compliance assessment consists of two parts. The first part assess the compliance of annual general meeting and auditing, where the second part deals with assessment of cooperative regulation. 3.3 The cooperative financial performance In line with the corporate governance research, this study used return on asset (ROA) and return on equity to measure cooperatives financial performance. Amadieu and Viviani (2010) and Boyd et al, (2007) in their study used ROA and ROE as a proxy to measure cooperative financial performance. 3

4 Z.Shamsuddin 3.4 Control variables Referring to previous literature relating to firm governance, we used cooperatives size, debt, and dividend growth, as control variables to cooperative financial performance. We contribute to the existing literature by applying cooperatives member benefit ratio in the model to reflect one of the objectives of most cooperative that is to offer benefit and returns to members, i.e. welfare funds, death benefits, education. 3.5 Summary of variables and cooperatives performance measure Summary of all dependent and independent variables used in this study are presented in Table 2. Table 2: Summary of variables and description Variable Symbol Description Dependent variable Cooperative financial performance lnroa Profit before tax / total assets at the end of the financial year lnroe Profit before tax/ total equity at the end of the financial year Independent and control variables Compliance score lncgcs Score from corporate governance compliance assessment by SKM DE ratio lnde Leverage DIV lndiv Dividend policy Firm Size lnfs Natural log of total assets at the end of financial year Members benefit lnmemben Total of members benefit/net profit for current year 3.6 Regression Model The following linear model has been developed to investigate the relationship between cooperative financial performance and cooperative governance compliance assessment using time-series cross section panel data. Financial performance it = ln CGCS it + 2 ln DE it + 3 ln FS it + 4 ln DIV it + 5 ln MEMBEN + it where i denotes the cooperative, t the examined time period, and ε is the disturbance term and Return on Asset (ROA) and Return on Equity (ROE) as a proxy to measure financial performance. Following Staikouraset al. (2008) among others, the log linear form is chosen as it typically improves the regression s goodness of fit and may reduce simultaneity bias. 4

5 The efficacy impact of corporate governance compliance on the financial performance of cooperative 4. Data Analysis 4.1 Descriptive analysis Table 3: Summary of descriptive analysis for each variable in Variables Mean Standard deviation Min Max lnroa lnroe lncgcs lnde lnfs lndiv lnmemben Table 3 shows the descriptive statistic to interpret the behavior of key variables of interest in this study. The dependent variable used in this study is cooperative financial performance as measured by lnroa. As table 3 shows, lnroa and lnroe has an average ratio of and respectively. The maximum and minimum for lnroa is and The CGCS scores are obtained from SKM that measures cooperative corporate governance compliance assessment score. The average of lncgcs score is which are just below the maximum score. The minimum score obtained is and the maximum is The average of lndebt-equity ratio of and standard deviation of scores a high volatility of the data. The mean of lndiv is standard deviation of reveals of low variability. 4.2 Multicollinearity test Multicollinearity happens when two or more independent variables in multiple regression are highly correlated (Gujarati, 2003). In order to detect for multicollinearity, this study conduct two approaches. The first one is to use Pearson Correlation Matrix (Hill et al., 2001). The rule of thumb is the correlation between the independent variables is more than 0.8 for a pair of independent variables, suggest for multicollinearity problem. Table 4: Result of Multicollinearity test Variables lnroa lnroe lncgcs lnlev lnfs lndiv lnmemben lnroa 1 lnroe 1 1 lncgcs lnlev lnfs lndiv lnmemben

6 Z.Shamsuddin Table 4 displays the Pearson correlation among the independent variables. The highest correlation is between lnroa i.e. members benefit and ROE. As it is lower than 0.8, therefore there is no multicollinearity problem. Another indicator to detect multicollinearity problem is through using Variance Inflation Factor (VIF) (Gujarati, 2003). As rule of thumb, if the value of VIF of independent variables exceeds 10 then that variable is said to be highly collinear with a series of variables (Gujarati, 2003). Mean VIF 1.36 Table 5: Resutl of VIF test Variable VIF Tolerance lndiv lnlev lnta lnmemben lncgcs Table 5 indicate that the highest VIF is 1.91 belonging to DIV i.e. dividend. Hence, there is no evidence on multicollinearity in the regression model due to no variable with high than 10, and mean VIF is also below Multivariate analysis For multivariate analysis of our panel data, this study first runs common-effect and random-effect regression. Then, Hausman test is done to decide between random or fixed effect. Since the null hypothesis is accepted, it is better for this study to used random effect. Table 6: Regression result with robust, for the effect of CGCS and ROA and ROE (N=269, t= ) Variables ROE and ROA Coefficient (standard error) CGCS (0.1040) LEV * (0.0308) LNFS * (0.2158) DIV (0.0386) MEMBEN * (0.0239) Constant (0.4693) Obs 261 R Prob > F (*significant level at 0.05). Based on the result presented in Table 6, there is no problem with the model as the prob>f is The regression result show CGCS have a positive impact (coefficient at ) on ROA an ROE 6

7 The efficacy impact of corporate governance compliance on the financial performance of cooperative but not significant value as the p-value is Other independent variables that have a negative effect and significant relationship to ROA are dividends and members benefit. 5. Discussion Table 6 shows the regression results of the relationship between efficacy of corporate governance compliance assessment score (CGCS) and cooperative financial performance. We find a positive effect of corporate governance compliance assessment on ROA but the effect is not significant. A 1% increase in ROA, the CGCS will increase by %. However, the coefficients is low (at ), indicating that the relationship is not very much linear. CGCS indicates a positive effect on ROE and not significant as the p-value is This is similar in terms of positive effect of corporate governance compliance score and ROA and ROE from previous empirical studies (Tariq and Abbas, 2013); (Dayha and McConnell, 2007). However, the relationship of CGCS and ROA and ROE in this study is not significant even though the coeeficient is positive. The results of negative correlation reveal a significant positive relationship between leverage, firm size, members benefit and ROA. Dividend policy have a negative effect on ROA and not significant. Where leverage and members benefit have a negative relationship and significant to ROE. The debt to equity ratio and dividend payout ratio is significant and is negatively associated with financial performance (ROA). Similar results also reported by Xu and Jiang (2014). The aim of this study is to find the efficacy of the current corporate governance compliance assessment by SKM to cooperative by evaluating the relationship between the corporate governance compliance assessment score and financial performance. The investigation shows that there is a significant positive impact to ROA and ROE but not significant and the magnitude of coefficient is low. The result does not support the expectation of this study that there is a positive impact relationship between CGCS and ROA, ROE. This indicate that the monitoring and controlling role of SKM to cooperative does not translate to improve or encourage cooperative to increase financial performance. Therefore, the current corporate governance compliance assessments do not provide evidence to improved cooperative financial performance. This gives a call to regulatory body to review their current governance assessment and identify new governance attributes that would contribute and improve cooperative financial performance. Being aware of our study limitation, the limited number of independent variables that describes the objective of cooperative, grouping cooperative according to their dividend policy and members benefit, we are appreciating as a challenge for our future research. Acknowledgements Author thanks Prof Abdul Ghafar Ismail (Islamic Research and Training Institute, Islamic Development Bank; Research Centre for Islamic Economics and Finance, Universiti Kebangsaan Malaysia) for reviewing of the paper and Zahir Dahari (SKM) for research assistance. References Amadieu, P. and Viviani, J. L. (2010). Intangible effort and performance: The case of the French Wine Industry. Agribusiness, 26, Bhagat, S., and Bolton, B. (2008). Corporate governance and firm performance. Journal of Corporate Finance, 14, Berle, A. A. and Means, G. C. (1991). The Modern Corporation and Private Property, USA, Transaction Publishers, New Brunswick, NJ (originally published in 1932). Black, S. B. Kim, W., Jang, H., and Park, K. S. (2009), How corporate governance affects firm value: evidence on channels from Korea. Working paper, Social Science Research Network, electronic library, available at: 7

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