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Effect of Corporate Governance Factors on Financial Performance of UK Companies

Effect of Corporate Governance Factors on Financial Performance of UK Companies


1. Introduction

Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of the many stakeholders in a company – these include its shareholders, management, customers, suppliers, financiers, government, and the community. Since corporate governance also provides the structure through which the objectives of the company are set, the means of attaining those objectives and monitoring performance are determined, it encompasses practically every sphere of management. Major corporate failures during the past decade have generated considerable interest in the area of corporate governance. Increased economic and financial globalization and the high-profile collapse of large companies, including the U.S. energy trading company Enron, the telecommunications company WorldCom, and the German payment processor Wirecard AG, in various parts of the world have highlighted an escalating concern about governance failure. These corporate failures often expose the widespread existence of serious corporate governance malpractices. As a result, policymakers and regulators worldwide have been keen to develop and introduce more effective corporate governance mechanisms. Other recent developments, such as the retirement of the combined code for directors of listed companies and the Companies Act 2006 in the UK, have also underlined the importance of ensuring an ongoing debate in the practice of corporate governance and further work to improve regulatory frameworks. The latter has created pressure for more research into the effectiveness of corporate governance regulation, including studies in the context of the stock market reaction to the introduction of the code, board structure, directors’ remuneration, and the impact of firms’ capital structure and corporate control mechanisms. Furthermore, the increasingly large number of empirical studies that have examined the relationship between corporate governance and financial performance show that there is a growing and robust consensus in the corporate governance literature of a positive relationship between certain governance structures and processes and financial performance. This study seeks to contribute to this controversial field by examining the relationship between governance and financial performance in the context of UK publicly-listed firms. However, the expression of this opinion will primarily explore five specific corporate governance variables and their association with financial performance as measured by accounting-based and market-based measures. The study will also add to a well-established area of academic literature that may be subject to future research. For example, a starting point in assessing the effect of a governance variable can be to perform a sectoral analysis to see whether any particular sector has a statistically significant impact on the relationship between that variable and financial performance, which is outside the scope of this study.

1.1. Background

The framework and laws for the corporate administration in the UK in the past were fundamentally founded based on the Financial Aspects of Corporation reports delivered in 1995 and 1998 that were overseen by Sir Ron Hampel and Sir Richard Greenbury. Specifically, in light of a legitimate concern for shareholder esteem and investors activism, there was a need to characterize the job, obligations and the reason for the board of the organization by deciding a suitable level and style of authority and leadership and furthermore to create straightforwardness in exposure and managerial practices. Besides, the independency of review, the constitution and the essential jobs and duties of the supervisory group were featured alongside the organization with shareholders and correspondence and data. The present practice direction for the corporate administration is related to the listing rules of the Financial Services Authority and the Bloomberg expert direction. As indicated by the listing rules for the UK markets set somewhere around the Financial Services Authority, any organization with a premium posting in the London Stock Exchange should follow and unveil in the yearly consistence report on its corporate administration code and system for example to completely follow the code or give a legitimate clarification on account of any deviation from guidelines or to require no release against specific principles. The reliance hypothesis fills in as a premise to build up the desires for how corporate administration works and, hence, supports financial specialists and minority financial specialists in the exercises that influence them by giving a consistent structure of reference.

1.2. Objective

The research hopes to provide a better understanding of the importance of these attributes, as well as their individual and combined impacts on financial performance. It also tries to unravel the complex relationship between governance mechanism and managerial pursuit. Finally, this paper also hopes to provide input that will be relevant for policy implications on why good governance matters for better financial performance of a firm. This has far-reaching significance because it is important for policymakers in creating awareness and making a case for the adoption of good governance practices and it also helps them in designing measures that help in alignment of the interests of the board, management, and the shareholders.

By contrast, internal governance mechanisms stipulate the relationship between the management and the owners of the firm. This research will delve into these governance mechanisms’ transverse relationship with the financial performance. The study also attempts to look into the influence of individual governance attributes. This is both relevant for theory development and managerial implications because managers tend to focus on separating different individual governance attributes with success in mind by using them as selection criteria.

First, most of the previous research papers have been carried out in developing countries. Therefore, this study aims to add to the growing empirical literature using a UK sample because the corporate governance and financial performance materials in developing countries, especially those from location-specific studies, have limited use in guiding decision makers when it comes to making a choice about broadening their investment and business locations and with the growing international investment opportunity.

The objective of this study is to examine the effect of corporate governance factors on the financial performance of UK companies. By employing the measures of financial performance used by previous related research and by having a board of directors and chief executive officer characteristics as governance indicators, this study seeks to contribute to the existing body of knowledge about corporate governance and financial performance in the following ways.

1.3. Scope

This research focuses on the effect of corporate governance factors on financial performance of UK companies using sample FTSE 350 firms as at 2016. The scope of this study is to evaluate the financial performance of firms using return on assets, return on equity and earnings per share as the dependent variables in the research. Also, the structure of the board (directors) will be considered in this study. This study will however not consider the following corporate governance factors that have been considered by the previous authors in their various researches: executive compensation and firm performance, mechanism of corporate governance and firm performance, corporate governance and audit quality, board size as correlate of corporate governance and financial performance of firm. Also, efficiency levels will not be taken into consideration in this paper. It is expected that this study will establish the empirical relationship between corporate governance and financial performance of the UK FTSE 350 companies. Also, an effective line of argument will be established by the researchers and empirical researches will be used wherever necessary to establish this relationship. The result of this study will help to add to the existing knowledge in the literature pertaining to corporate governance and financial performance. Also, policy implications will also be drawn from the results of the study and the firms that will adopt a divergence from the findings will be exposed to shareholders’ litigations.

2. Literature Review

2.1. Definition of Corporate Governance

2.2. Importance of Corporate Governance

2.3. Previous Studies on Corporate Governance and Financial Performance

3. Methodology

3.1. Research Design

3.2. Data Collection

3.3. Sample Selection

3.4. Variables and Measurements

4. Corporate Governance Factors

4.1. Board Composition

4.1.1. Independence of Directors

4.1.2. Board Size

4.1.3. Diversity of Directors

4.2. CEO Characteristics

4.2.1. CEO Duality

4.2.2. CEO Tenure

4.2.3. CEO Ownership

4.3. Ownership Structure

4.3.1. Institutional Ownership

4.3.2. Insider Ownership

4.3.3. Ownership Concentration

5. Financial Performance Measures

5.1. Return on Assets (ROA)

5.2. Return on Equity (ROE)

5.3. Earnings per Share (EPS)

6. Analysis and Findings

6.1. Descriptive Statistics

6.2. Regression Analysis

6.3. Interpretation of Results

7. Conclusion and Recommendations

7.1. Summary of Findings

7.2. Implications for UK Companies

7.3. Recommendations for Future Research


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