The association between ISO 9000 certification and financial performance

The association between ISO 9000 certification and financial performance Lamport M Seetanah B Conhyedass P Sannassee R V INTRODUCTION Le Meridien Hotel, Mauritius, 24-27 August 2010 1

ISO 9000 is currently used by thousands of companies the world over to be more efficient and effective in the delivery of their products and services and ultimately to better satisfy their customers needs. The latest statistics released according to ISO (2009) show that as at December 2009 nearly a million certifications were issued in 175 countries. This suggests that there is a widespread belief in the business benefits of ISO 9000 accreditation and that it is increasingly viewed as the benchmark quality standard (Marquardt, 1992). Many companies view ISO 9000 as a passport for doing business globally. In fact, it is a basic requirement for government tenders in many countries. Companies seek ISO 9000 in order to gain internal efficiency, effectiveness and ultimately profitability. ISO 9000 registration is believed to bring about numerous benefits to organization such as improved communication among employees, cost savings, reduced paperwork, more organized design and output, greater competitive advantage, access to global markets especially for small firms, fewer customer audits, improved productivity, a better trained workforce, increased customer confidence as well as providing a foundation for TQM and overall financial performance and growth. Despite the number of benefits in favour of ISO 9000, whether the standard actaully improves business performance and profitability remains debatable. Moreover, although there is a variety of research articles describing implementation of ISO 9000 quality systems and examining success stories, there is little research that really examines whether there id a positive link between companies certified as ISO and their financial performance. As Juran (1999) noted there is a lack of research that can shed light on the benefits we are getting from all that costly certification the ISO 9000 series of standards. The criticism is justified since most studies have examined the impact of ISO certification on self-rated performance measures such as customer satisfaction, productivity and product quality. Similar to other countries, most of the studies conducted in Mauritius have focused on the link between efficiency and effectiveness of ISO certified firms and the perception of employees and customers in relation to implementing ISO quality management system. Therefore, a study of the effect of ISO 9000 certification on financial performance of companies is important in order to mitigate the limitations of prior studies. This research broadly empirically assesses the effects of ISO 9000 certification on financial performance. With this objective in mind, an econometric framework related to panel data analysis, with firms list on the stock exchange of Mauritius, will be used. The remaining part of the paper is organized as follows: section 2 reviews the literature on studies that have examined an possible association between ISO 9000 certification and performance indicators, both financial and non-financial. Section 3 consists of an historical overview of the international meta-standard both worldwide and in Mauritius. Section 4 is the methodology that is proposed and undertaken to conduct the research. Section 5 specifies the analysis and results that Le Meridien Hotel, Mauritius, 24-27 August 2010 2

are obtained to determine whether there is a link between ISO 9000 certification and financial performance. Finally, section 6 concludes the paper. RELATED LITERATURE Two important theories in the literature are identified that explain possible sources of gains following ISO 9000 certification. Both theories give a consistent view that performance of certified firms exceeds performance of uncertified firms. The two theories are known as Internal Improvement theory (including Quality awareness Productivity and efficiency theories and External Improvement theory (see Sharma, 2005 for an extensive review of the theoretical literature). Although there is an overwhelming number of studies focusing on the impact of ISO 9000 certification on non-financial performance indicators 1 literature.(see Abdalsalam Mohamed A.Gader, 2004). Chua, Goh and Wan (2002), Madg, Kadasah, Curry (2003), McAdam and Mckeown (1999), Quazi and Jacobs (2003), Anderson et al (1999), Costa and Lorente (2004) among others), relatively few rigorous studies can be traced on the effects of ISO 9000 certification on financial performance. For instance, Corbett, Montes, Kirsch and Gil (2002) used an event study to analyse the impact of ISO certification on performance of 373 US companies and found that their ROA was improved relatively through superior cost control and higher sales. Like Heras et al. (2002), Chua, Goh and Wan (2002) also reported that ISO certification leads to better overall financial performance for listed and non-listed companies from a survey undertaken on 146 firms on the Singapore Stock Exchange over a ten year period. Similar results were also found from Sharma (2005) for a sample of 70 companies listed on the Singapore Stock Exchange over a 6-year period. Recent studies also tend to confirm these beneficial effects; for instance Lo, Yeung and Cheng (2007) undertook a study for 695 publicly listed manufacturing firms and found that ISO 9000 certified companies shortened their operating cycle time by 5.28 days one year after the implementation of ISO 9000. Bayati and Taghavi (2007) demonstrated in a study in Tehran that after acquiring ISO 9000 certification, the performance of small-to medium-sized enterprises (SMEs) improved. Costa and Lorente (2007) use financial ratios on a longitudinal approach to analyse the performance of 713 Spanish manufacturing companies and observed that companies that implemented ISO 9000 obtain considerably less earnings and ROA during the three years following registration. However, Feng, Terziovski and Samson (2007) in a study based on 613 manufacturing and service companies in Australia and New Zealand validated that ISO 9000 Certification had a positive effect on operational 1 Non financial performance indicators consist of self rated measures such as customer satisfaction, quality, motivation and productivity Le Meridien Hotel, Mauritius, 24-27 August 2010 3

performance (internal operation performance) but a positive weak effect on business performance (financial performance). Other studies Aarts and Vos (2001) for the case of New Zealand market found that share prices did not react to ISO 9000 registration announcements. Lately Caspitrano (2008) found that out 49 Philippine companies listed in Business World s Top 1000 corporations, only a few improved their financial performance after ISO certification. A brief review of the literature suggests that the results of ISO certification effect on financial performance is at best mixed. Our study will attempt to bring addition insights on the debate and supplement the literature by bringing new empirical evidence form a small island economy. RESEARCH METHODOLOGY The sample A sample of Mauritian incorporated companies listed on the Stock Exchange of Mauritius were chosen for this study. Companies which were only partially ISO 9000 certified and those which gained their certification recently were excluded for this research. Therefore, the final sample consisted of 10 certified companies and 10 non-certified companies with data up to 12 years for each for the 1997-2008 period. The Model Specification For this study, earnings per share (EPS) is used as dependent variable to measure overall financial performance of firms. The Independent variables are given below together with a brief justification for their inclusion: Sales is used since it is believed that an ISO 9000 certified firm attracts more customers compare to a non-iso certified firm thus increasing sales. Foker et al., (1996) found that quality defined as conformance to specification was significantly related to sales growth through the fact that better quality attracted and retained more customers. Operating expenses is included since ISO 9000 is supposed to reduce internal costs and thus improve business performance (Maani et al., 1994; Flynn et al., 1995). This is also in line with Deming (1986), who purports that as quality improves, waste is eliminated leading to a reduction costs and an improvement in financial performance. Size (Company size) is included to control the size effects on performance. Age is included because Finley and Buntzman (1994) argued that the performance of a company is influenced by its age. Age refers to the number of years a company is listed on SEM. ISO Status is coded as ISO Status: ISO 9000 certified=1 and non-iso 9000 certified=0. The variable ISO status is used in the pooled panel data. Le Meridien Hotel, Mauritius, 24-27 August 2010 4

The econometric model takes the following general form: EPS =α + β 1 Sales + β 2 Size + β 3 Opexp + β 4 Age + β 5 ISOstatus+ ε Where Sales = total Sales of the company Size = total assets Opexp = total operating expenses of the company (distribution expenses + administrative expenses + other expenses) Age = number of years listed on the Stock Exchange of Mauritius ISOstatus = (ISO Status: ISO 9000 certified = 1 and non-iso 9000 certified=0) Fixed Effects and Random Effects: The Hausman Specification Test To determine whether fixed or random effect should be used, a Hausman test (Hausman, 1978) has been run in order to know whether the null hypothesis, namely that the individual effects are uncorrelated with the other regressors in the model, is not rejected and a random effect model is better than its fixed counterpart. Results of the Hausman test show that as the test statistic is large and the Prob > chi2 = 0.0001, the null hypothesis is rejected and the Hausman test favours the fixed effect estimator. Empirical Analysis The results of the panel regression are shown in the table below. Le Meridien Hotel, Mauritius, 24-27 August 2010 5

Dependent variable: EPS Independent variables Coef t statistics sales Size Opexp Age status Intercept -3.169 2.55** 3.72** 7.29* 2.56** -17.393* -1.34 2.28 2.14 1.89 2.17-1.81 Prob > F R Squared 0.0002 0.43 * =10%; **=5% ; *** =1% EPS = -17.39373 4.169713lnsales + 2.45553lnSize + 3.622375lnOpexp + 7.2962lnAge + 2.873174ISOstatus + ε From the Table, it can be seen that all variables p-values are significant (except sales) and they have a positive impact on EPS. As the variable Sales increases by 1 unit, EPS will decrease by 3.169, holding other independent variables constant. Even though, there is a negative relationship between EPS and Sales, the model is statistically insignificant with p-value for variable of 0.001 and thus it is concluded that Sales is not associated upon EPS and this is inconsistent with the literature. A oneunit increase in Size yields a 2.55 increase in the predicted EPS, holding all other independent variables constant. Therefore, there is a positive effect on EPS. The regressor Size adds value to the model with p-value 0.030. It is thus concluded that Size has a positive relationship with EPS. Ceteris paribus, a one unit increase in operating expenses (Opexp) increases the independent variable, EPS, by 3.72. The model is statistically significant with p-value < 0.05. It is thus concluded that the variable Opexp has an impact on the overall financial performance (EPS). A one-unit increase in Age, holding the other independent variables constant, increases the dependent variable, EPS, by 7.29. The p-value of Age is significant at 10%. Therefore Age has a positive impact upon EPS. This is in line with Finley and Buntzman (1994) who argued that the age of a company influenced its performance. Thus, it may be concluded that the longer a company is listed on the SEM, the more positive is its performance. This is because the company is more able to face any liquidity problems compared to those firms which are in a state of infancy. Besides, those companies which are listed on SEM have a market capitalization greater than 20 million and have the privilege of issuing shares to finance their transactions. Le Meridien Hotel, Mauritius, 24-27 August 2010 6

Finally, as the variable of interest ISOstatus is concerned, it would appear that iso certification results in a positive impact on EPS, ceteris paribus. Therefore, there is a positive association between EPS and the outcome variable, ISOstatus. With p-value of 0.037, the model is statistically significant and confirms the studies of (i) Corbett, Montes, Kirsch and Gil (2002) for US companies,(ii) Chua, Goh and Wan (2002) and Sharma (2005) for the case Singaporean firms, (iii) Bayati and Taghavi (2007) for firms operating in Tehran and (iv) Costa and Lorente (2007) for the Spanish firms. Furthermore, the F test (0.0001<0.05) indicates that the independent variables add value to the model and thus is statistically significant. The results passes all diagnosis tests relating to heteroskedasticity (Modified Wald test), Autocorrelation (Durbin Watson Test) and Multicollinearity (VIF and Tolerance). However, these results suggest that the benefits from ISO 9000 certification cannot be denied. Most importantly, whether the benefits of ISO 9000 certification come from the internal efficiencies or external efficiencies cannot only be explained by the above results since there may be other unexplained factors. CONCLUSION This research inquired whether there is an association between ISO 9000 certification and financial performance. Our study contributes more in terms of evaluating performance of businesses by the use of financial performance indicators compare to the preceding studies done on self-rated measures. Using a sample of 10 ISO 9000 certified firms and 10 Non ISO certified firms across a range of sectors, ISO 9000 certification in a panel regression framework for 12 years, results from the analysis provide evidence that ISO 9000 certification is associated with improvements in overall financial performance and such results are in line with the latest evidences particularly the Singapore case. Le Meridien Hotel, Mauritius, 24-27 August 2010 7

Certified ISO companies Automatic Systems Ltd Mauritius Eagle Insurance Co Ltd United Basalts Product Ltd Plastic Industry (Mauritius) Co. Ltd Phoenix Beverages Ltd Non ISO Certified companies National Investment Trust Swan Insurance Co. Ltd United Docks Ltd Mauritius Oil Refineries Ltd Mauritius Union Assurance Co. Ltd APPENDIX 1 Reference Le Meridien Hotel, Mauritius, 24-27 August 2010 8

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