Impact of Corporate Governance on Firm Performance: Evidence

from Sugar Mills of Pakistan.

Umar Saeed – CMS 20533, Usman Munawar- CMS,

Bilal Farooq-CMS 20480 & Hashir Mehmood-CMS 20493

Spring 2018, MCOM (III)

Faculty of Management Sciences Riphah International University

Umar_3451@hotmail.com, 0307-8949199, 0307-5673747

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Contents
Abstract...........................................................................................................................................4
Chapter 1.........................................................................................................................................5
Introduction:....................................................................................................................................5
Family and Non-family Firms.....................................................................................................8
Corporate governance and performance...................................................................................10
Corporate governance mechanisms..............................................................................................12
Board size..................................................................................................................................12
Board structure..........................................................................................................................13
Sugar industry in Pakistan.............................................................................................................13
Gap Identification:........................................................................................................................14
Problem Statement........................................................................................................................14
Research Objectives......................................................................................................................14
Chapter 2.......................................................................................................................................16
Literature Review..........................................................................................................................16
Theoretical frame work.................................................................................................................19
Chapter 3.......................................................................................................................................21
Methodology.................................................................................................................................21
Model............................................................................................................................................21
Explanation of Variables...............................................................................................................23
(a) Board Size............................................................................................................................23
(b) Board composition..............................................................................................................25
(c) Duality.................................................................................................................................25
Chapter 4.......................................................................................................................................27
Results:..........................................................................................................................................27
Table 1. Descriptive Statistics...................................................................................................27
Table 2. ANOVAb.....................................................................................................................27
Table 3. Model Summary.........................................................................................................28
Table 4. Coefficientsa................................................................................................................29
Conclusion....................................................................................................................................30
Limitation of the Study.................................................................................................................30
Recommendations:........................................................................................................................30
References.....................................................................................................................................32

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3
Abstract
This paper examines the impact of corporate governance mechanisms (Board Size, Board
Composition, and CEO/Chairman Duality) on firm performance (Return on Asset) in sugar
industry of Pakistan. The data of corporate governance mechanisms (Board Size, Board
Composition, and CEO/Chairman Duality) collected from 12 listed sugar mills of Pakistan from
2005 to 2010. Using panel data methodology as a method of estimation Arithmetic mean,
ANOVA and t-test applied on data by using SPSS. The results raveled that there is a significant
impact of corporate governance on firm performance. Results further reveal that there is a
significant impact of board size, CEO/Chairman Duality on ROA, and there is insignificant
impact of Board Composition on ROA.

Keywords: Corporate governance, Board of director, firm performance

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Chapter 1
Introduction:
Corporate governance is one of the key areas of business which enhances the courage of
investors and allow for protecting their interest. The significance of corporate governance is
realized by the investors, corporations and governments for competing domestically and
internationally (Owen, 2003). In academic researches, corporate governance has got great
concentration in developed and developing countries (Mallin, 2004; Reed, 2002; Solomon &
Solomon, 2004; Weir & Laing, 2001). A need was felt for sound corporate governance practices
especially in developing countries due to financial scandals in past (Baydoun, Maguire, Ryan &
Willett, 2013). Great consideration has been devoted to corporate governance in under-
developed economies as many of these lacks appropriate corporate governance practices
(Ekanayake, Perera & Perera, 2010).

Corporate governance is important for economic development of Pakistan as it plays a key role
in economic growth of a country. The Securities and Exchange Commission of Pakistan (SECP)
has centered its regulatory measures in promoting investors’ confidence to uphold sound
corporate governance to make sure transparency and accountability in the corporate sector and
protect all stakeholders particularly minority stakeholders. Code of corporate governance for
Pakistan was issued by SECP in March 2002 and it was included in the listing regulations of
firms in PSX.

All the firms strive to attract corporate investors in national and global financial market by
paying maximum amount of wealth on invested capital. Wealth maximization occurs when stock
price is increased for current shareholders. Maximization of shareholders wealth is the primary
goal of every firm (Van Horne & Harlow, 2009). The goal of shareholders and other corporate
stakeholders including lenders, employee, business associates, society at large and government
is accomplished if there exists sound governance in companies. If companies are governed
poorly, will face poor financial performance (Hashim, Khattak & Kee, 2017). It is believed that
practice of corporate governance is an internal mechanism for operation of corporations. It can
instill investors’ confidence and effect corporate financial performance. According to Ghabayen,
(2012) corporate governance is a useful tool for guaranteeing excellent performance.

This research is conducted for analyzing the impact of corporate governance on financial
performance of cement sector firms listed on PSX from year 2005 to 2014. Insider directors,

5
institutional shareholdings and board independence are used as the facets of corporate
governance, whereas, financial performance is measured through return on assets and return on
equity.

The system by which the companies are governed and controlled is known as corporate
governance. In simple words we can say that the framework through which the interests of
various stakeholders are balanced “It indicates a set of relationships between a company’s board,
its management, its shareholders and other stakeholders. The mechanism of solving the
problems of various corporate stakeholders such as creditors, shareholders, employees,
management, consumers and the public at large is provided by corporate governance.

Corporate governance also includes the relationships among the many stakeholders involving
external stakeholders and internal stakeholders. In contemporary business corporations, the main
external stakeholders are shareholders, debt holders, trade creditors, suppliers, and customers.
Internal stakeholders are the board of directors, executives, and other employees. Good and
proper corporate governance is considered imperative for the establishment of a Competitive
market. Corporate governance practices stabilize and strengthen good capital markets and
protect investors. They help companies to improve their performance and attract investment.
Corporate governance enables corporations to attain their corporate objectives and to protect the
rights of shareholders.

Pakistan has been experiencing phenomenal economic growth in the past few years, leading to a
sizeable increase in the number of unlisted companies, particularly family owned organizations.
The Securities & Exchange Commission of Pakistan has recently reported that the total number
of non-listed companies has now surpassed the 50,000 mark.

The sharp growth in such companies is fueling the growth of Pakistan’s private sector, making
good governance even more important for businesses. Currently, the Code of Corporate
Governance only ensures compliance for companies listed on the stock exchanges. Introducing
the concept of good corporate governance is vital for the continuity and sustainability of the
unlisted companies that support economic growth in Pakistan.

Family-owned companies are characterized as organizations in which the shareholders belong to

the same family and participate substantially in the management, direction, and operation of the
company. It is widely recognized that each family has its own unique unwritten rules, values,
histories, and communication methods. As the family structure shrinks or expands, the company
changes, particularly with the advent of the second and third generations. Changes instigated by

6
new generations can improve or harm the business. A recent survey suggests that only 15% of
family owned enterprises continue to survive to the third generation. Of those that do last, 85%
either disintegrate or completely vanish before the fourth generation takes the reins.

Families have a number of unique attributes that serve to strengthen a family business, including
love, care, unconditional acceptance, generational hierarchy, emotion, informality, closeness,
loyalty, commitment, stability, relationships, growth and development, safety, support, and
tradition. Families can also have a number of negative traits such as anger, tension, confusion,
competitiveness, and strangled communication, which can affect a company to the detriment of
all. These qualities are reflected into business ownership methods and styles, and can support or
harm a company. Good governance mechanisms can alleviate some of the problems that arise
when family characteristics become a driving force behind company action.

Despite having a close network of owner/directors and the ability to make decisions quickly,
family-owned companies are generally unable to sustain growth and have a shorter lifecycle than
a privately owned company. In Pakistan, amongst the so-called 22 families identified in the
Ayub era, only a few have managed to retain their prestigious position. Research shows that
family-owned companies’ shorter lifespan is mainly due to the following attributes:

1. Clear lines of succession do not exist or are complicated by the importance of

familial relationships.
2. Loose organizational structures do not attract and retain quality human resources.
3. Personal interest in the success of the business leads to an unwillingness to take risks
like expanding and diversifying into new business ventures.

It is internationally recognized that good governance has a positive impact on the performance
of companies and enables them to move into the next phase of the business lifecycle. As
companies grow and become more conversant with good governance, their ability to attract
capital from external sources also improves, allowing them to expand, diversify, and acquire
other businesses in a sustainable manner.

Good governance directly addresses the above issues for family-owned companies by:

• Integrating the strengths of family and business.

• Improving shareholder relationships through effective communication and conflict
management.
• Systemizing wealth distribution mechanisms.

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 • Supporting growth and business diversification.
• Managing ownership and leadership transitions.
• Developing the next generation of managers, shareholders, and family members.
• Improving credibility.
• Attracting lower-cost debt and equity capital.

The principles of good corporate governance are as useful for non-listed companies as for listed
companies. In countries like Pakistan, where a corporate governance code has been established
for listed companies, these principles can be practiced by family-owned and nonlisted companies
as well. Some countries – including Egypt, Turkey, Belgium, and Finland – have also developed
indigenous, voluntary corporate governance guides for non-listed, family owned companies.

In Pakistan, family-owned companies are often private limited companies. Shares are held by a
small group of people and there are limits on transferability. When this small group of people,
however, is a family in conflict, the company suffers from a lack of objective analysis on the
part of independent directors. Creating mechanisms like family constitutions and family councils
can manage corporate governance apart from the family so the business does not suffer.
Additionally, good governance practices can assist in creating a more sustainable organization
by delineating methods for generational transitions and succession planning.

Family-owned, listed companies are the backbone of Pakistan’s economy. However, these
companies are traditionally either unaware of the general principals of good corporate
governance, or work in a relatively less open environment. Promoting basic principles of good
governance for family-owned companies is crucial in supporting the development of a strong
economic sector.

Family and Non-family Firms

Family-owned companies are the organizations in which the shareholders (or) members belong
to the same family and they take part in the management of the company and direct and operate
the company. It is general concept that each family possess certain rules, has their own values, &
histories, and communication styles.

Some families have a number of unique characteristics which serve as a strength to a family
business, which include love, care, emotion, closeness, loyalty, stability, relationships, growth
and development, safety, support, customs and traditions. Families may also have a number of
negative aspects such as anger, tension, confusion and competitiveness, which can affect a

8
company . These qualities can support or harm a company. Family and Non-family businesses,
is a burning issue in all over the world. Family own businesses are increasing day by day
according to analysis that 60% of the businesses are family own and remaining 40% are the non-
family controlled businesses. There is no application of principles and rules of corporate
governance in family own businesses that are major part of the economy. There is a shortage of
research studies on family own and non-family own businesses in Pakistan, so there is wide gap
of research on these businesses in Pakistan. The aim of the study is to fill this gap. In this study
cement industry in Pakistan judged in term of earning per share (EPS). The firm performance
has been judged on accrual basis system as well as on cash base system. For the purpose of
accrual bases system, statement of profit & loss is analyzed and for cash basis system, cash flow
statement is analyzed.

A family business refers to a company whereby the voting majority is in the hands of the
controlling family; including the founder(s) who intend to pass the business on to their
descendants. The terms “family business”, “family firm”, “family company”, “family-owned
business”, “family-owned company” and “family-controlled company” can be used
interchangeably.

A family-owned business may be defined as any business in which two or more family members
are involved and the majority of ownership or control lies within a family. Family-owned
businesses may be the oldest form of business organization. Farms were an early form of family
business in which what we think of today as the private life and work life were intertwined. In
urban settings it was once normal for a shopkeeper or doctor to live in the same building in
which he or she worked and family members often helped with the business as needed.

Since the early 1980s the academic study of family business as a distinct and important category
of commerce has developed. Today family owned businesses are recognized as important and
dynamic participants in the world economy. According to the U.S. Bureau of the Census, about
90 percent of American businesses are family-owned or controlled. Ranging in size from two-
person partnerships to Fortune 500 firms, these businesses account for half of the nation's
employment and half of her Gross National Product. Family businesses may have some
advantages over other business entities in their focus on the long term, their commitment to
quality (which is often associated with the family name), and their care and concern for
employees. But family businesses also face a unique set of management challenges stemming
from the overlap of family and business issues.

9
 Family controlled companies have higher sale growth and great improvement in net margin as
compared to non-family businesses. It is found by that family owned firms are more efficient
and valuable in contrast to non-family own companies. A study made by, that family control
firms have high profitability as non-family constitute low profitability. There is no difference
regarding performance between family and non-family controlled firms.

Family owned business

Family owned and managed

business Family
business
Family owned and led
business

Corporate governance and performance

Numerous studies have investigated the connection between corporate governance and firm
performance (Yermack, 1996; Claessens et al., 2000; Klapper and Love, 2002; Gompers et al.,
2003; Black et al., 2003; Anda et al., 2005), with mixed results. Adjaoud et al. (2007) concluded
that there is little evidence of a systematic relationship between the characteristics of the board.
Bhagat et al. (2000) and Weir et al. (1999) observed a positive relationship between corporate
governance and firm performance but Albeit et al. (1998) observed a negative relationship
between them. Corporate governance contains various aspects of complex regimes as Zingales
(1998) also examines it as a comprehensively broad, multifaceted notion that is enormously
relevant, while difficult to define, due to the variety of scope that it encompasses. Friend and

10
Lang (1998) examine that shareholders, having high concentration in firms, play an important
role to control and direct the management to take keen interest in benefit of the concentration
group. However, corporate governance command also allows shareholders to direct the
management for betterment of their investment.

Shleifer et al. (1997) urged that concentration groups with large shareholdings; check the
manager’s activities better. However, only the check and balance not only causes to reduce the
agency cost but as well resolves the issues between managers and owners. Furthermore,
Williamson (1988) examined the relationship between corporate governance and securities.

Jensen (1986) seems to be quite keen to analyze how corporate governance directly or indirectly
influences the capital structure and firm value. Driffield et al. (2007) stated that higher
ownership concentration has a positive impact on capital structure and firm value. In the other
case, lower ownership concentration, the relationship depends upon the strictness of managerial
decision making which enforce to bring change in the capital structure. Gompers et al. (2003)
analyzed the relationship between corporate governance, long-term equity returns, firm value
and accounting measures of performance, while Rob et al. (2004) found combined relationship
between corporate governance, firm value and equity returns.

The Code of Corporate Governance (2002) issued by Securities and Exchange Commission of
Pakistan describes the following benchmarks for international best practices.

1. The roles of the board of directors

1. The business of a firm is managed under the direction and supervision of a board of
directors who delegates to the CEO and other management staff for day to day
management of the affairs of the firm.
2. The board sees to the appointment, compensation, monitoring and replacing (in worse
case) the executives.
3. Oversight of insider conflicts of interest, including misuse of company assets and abuse
in related party transactions.
4. The directors, with their vast wealth of experience, provide leadership and direct the
affairs of the business with high sense of integrity, commitment to the firm, its business
plans and long-term shareholder value.
5. The board provides other fiduciary duties.

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Corporate governance mechanisms
There are many dynamics or variables that may constitute benchmarks by which corporate
governance can be measured in an organization. Some of these mechanisms are briefly discussed
following.

Board size
Corporate Governance Codes recommend boards not to be too big and an ideal size of board is
between 5 to 16 depending on the size and diversification of the organization.

Jensen (1993) attributes ineffectiveness of large boards to the rather undue emphasis on courtesy
politeness associated with bigger groups rather than being frank and truthful. Some board
members are implicitly coerced into agreeing to boardrooms decisions albeit; with some
reservations which they fail to voice out. The agency problem also increases with board size as
there are more conflicting groups representing their own diverse interests. In addition Free-
riding also increases as some directors neglect their monitoring and controlling duties to other
colleagues on the board. Most companies also have a representative of minority shareholders on
board that is not usually increased with increasing board size (Drobetz et al., 2004b). Brown and
Caylor (2004) also suggest that a board size between 6 to 15 members is ideal to enhance the
firm performance. Yermack (1996) documented that those firms having small board sizes have
higher stock market value. He finds an inverse relationship between firm value and board size by
using a sample of large United States corporations. Mishra et al. (2001) stated that smaller
boards help to make decision more quickly. Kathuria and Dash (1999) argued that firm's
performance increases if the board size increased but the contribution of an additional board
member decreases as the size of the board increases.

Studies that find a negative relationship between board size and firm performance include
Eisenberg et al. (1998), Carline et al. (2002), and Mak and Yuanto (2002). Aggarwal et al.
(2007) found no relationship on board size and firm valuation.

Board structure
Corporate Governance indices bestow higher rating to firms with independent boards. Hermalin
and Weisbach

(1991), and Bhagat and Black (2002) found no correlation between the degree of board
independence and four measures of firm performance, controlling for a variety of other
governance variables, including ownership characteristics, firm and board size and industry.

12
These researchers found that poorly performing firms were more likely to increase the
independence of their board. Dare (1998) state that non-executive directors are effective
monitors firm's strategy related issues. They are able to provide independent expert judgment
when dealing with the executive directors in areas such as pay awards, executive director
appointments and dismissals. O'Sullivan and Wong (1999) recorded that, non-executive
directors in the board become less effective if they continue with the same board for many years.

Baysinger and Hoskisson (1990) found that nonexecutive directors and part-time employed
board members which limited their scope in understanding the complexities entailed in making
informed decisions. Mac Avoy et al. (1983), Baysinger and Butler (1985) and Klein (1998)
found that firm performance is insignificantly related to a higher proportion of outsiders on the
board but Forsberg (1989) found no relationship between the proportion of outside directors and
various performance measures. Thus, the relation between the proportion of outside directors
and firm performance is mixed.

In Pakistan, Code of Corporate Governance has restricted listed companies that executive
Directors must not be more than 75% of total board size; also encourage the representation of
minority shareholders and independent directors.

Sugar industry in Pakistan

At the time of independence in 1947 there were only 2 sugar factories in Pakistan. The output of
these factories was not sufficient to meet the domestic requirements of the country, and then
sugar was imported from other countries. and at that time huge foreign exchange was spent on
sugar. The first sugar mill was established in 1961 at TANDO MUHAMMAD KHAN in Sindh.
During 1997-1998 there were 75 sugar mills in the country and produced 2.4 million metric ton
sugar.

Sugarcane is an important industrial and cash crop in Pakistan. And it is 2nd largest agro –
industry in Pakistan after textile. Pakistan is the 15th largest sugar producer, 5th largest in terms
of area under sugar cultivation, 60th largest country in sugar yield in the world. Currently there
are 83 sugar mills in Punjab, Khyber Pakhtoonkhwa (KPK), and in Sindh. In addition to sugar
sugarcane also provide a number of other products like: alcohol used by pharmaceutical sector,
bagasse in paper and press mud used as a source organic matter and as a source of energy for
bricks makers.

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Measuring firm performance using accounting ratios is common in the corporate governance
literature, in particular, return on capital employed and return on assets.

Gap Identification:

There is a shortage of research studies on family own and non- family own businesses in
Pakistan, so there is wide gap of research on these businesses in Pakistan. The aim of the study
is to fill this gap. In this study sugar industry in Pakistan judged in term of earning per share
(EPS). The firm performance has been judged on accrual basis system as well as on cash base
system. For the purpose of accrual bases system, statement of profit & loss is analyzed and for
cash basis system, cash flow statement is analyzed.

Problem Statement

What is the impact of Family & Non-family controlled firms, CEO duality, and board size on the
performance of firms in Pakistan. To know the performance of the business, many factors can be
kept in mind like profitability (cash basis profitability and accrual basis profitability), productive
efficiency, and earning per share of the firm. In a study of impact of CG, klapper and love
(2004) have argued that CG is more relevant in firms that employ intangible assets.

Research Objectives

1. To make a contribution to Corporate Governance research in Pakistani industry.

2. To measure the effect of the Corporate Governance on Firm performance in the sugar
industry of Pakistan.

3. To examine the impact of corporate governance on firm’s profitability in sugar sector of

Pakistan.

For the purpose of this study, as Independent variables, we are using Board size, Duality and
Board Composition and the firm performance (Return on Assets) as the dependent variables.

14
Chapter 2

Literature Review
It is imperative for business organizations to generate maximum profit in order to survive,
compete and grow in the market. Profit maximization is the primary goal of every business firm
which can be accomplish by applying sound corporate governance practices. If firms will
distribute sound amount of dividend amongst current shareholders, on time payment to creditors
and government agencies, protect the interest of employees and act as good citizen by applying
good corporate governance mechanism then firms can instill confidence of all stakeholders.
Corporate governance has traditionally been related with the principal and agent or agency
conflict. Principal and agent relationship occurs when those who own a firm is not alike as those
who manages or controls the firm. Agency theory has its heredity in theories of economic,
developed by Jensen and Meckling in 1976. The theory of Agency states that shareholders
(principal) who are real owners of corporations assign the operation of corporation to managers
(agents). The principals anticipate that agents will work in the best interest of corporation and
will make decisions which will increase firm’s value. However, the interest of agents may
diverge from principal.

Corporate governance plays a vital role in accomplishment of organizational goal across the
globe due to emergence of markets, trade liberalization, financial crises, capital mobility and
technological advancement. Corporate governance is considered as mainstream concern in
structure of corporation in corporate board in all business (Claessens, Djankov & Lang, 2000).
According to Edwards & Nibler, (2000) corporate governance systems perform a significant role
in financial performance as they present mechanism which effect investment’s return for
suppliers of finance to corporation. Nestor and Thompson, (2000) have categorized these
systems into two kinds: Anglo Saxon Model and Continental Model. Anglos Saxon Model
inclined to depend on managers’ compensation for corporate control, whereas, Continental
Model inclined to rely on several stockholders to support the managers and owners behavior.
The Anglo Saxon model is based on concept that ownership stake and decentralized market can
perform in a self-controlled, balanced manner and is founded on notion of capitalism market
(Cernat, 2004). Therefore,
corporations have normally same systems of corporate governance in Anglo American countries:
UK, US, Australia and Canada. In this model, management activities are monitored and
controlled by one independent board of directors for maximizing wealth of shareholders. The

15
Continental Model of corporate governance focus on analyzing on the stakes of crew, managers,
clients, suppliers and community, which aid innovations and competitions (Giurca Vasilescu,
2008; Hashim, 2014).

The code of corporate governance was firstly notified in 2002 in made compulsory for listing of
companies on stock exchange(s) in Pakistan. Corporate stakeholders are affected by the financial
performance. The stake of each stakeholder mostly clash with the interest of other. Amongst
them only few stakeholders possess more control in decision making. A system is needed which
can serve and protect the individual and collective stake of each stakeholder and protect
exploitation of each stakeholders interest and from the monopoly of individual stakeholder in
decision making. Corporate governance is the system used for attaining the individual and
corporate stake (Butt, 2012). According to the Organization for Economic Cooperation and
Development (OECD) principles of corporate governance, (2015) corporate governance is the
amalgamation of relationship in shareholders, board, management and rest of stakeholders.
According to Audit Commission, (2009) and Chartered Institute of Public Finance and
Accountancy and the Society of Local Authority Chief Executives, (2007) emphasize the
essential component of accountability and controlling in corporate governance. The fundamental
objective of corporate governance measure is to direct and control in order to bring transparency
in corporations which in return effect financial performance of companies. Financial
performance is subjective gauge of how efficiently an organization could utilize entire resources
to produce income. Financial performance could be use a common measure of the entire
financial situation during particular time period and could be use to evaluate same firms across
the similar industry or to evaluate aggregate sector. Barbosa and Louri, (2005) applied return on
assets, earning per share, sales growth, market capitalization and dividend earning to measure
financial performance. (Davies, Hillier & McClogan, 2005; Kapopoulos & Lazaretou, 2009)
support the fact that insider directors directly effect firm financial performance of firm. Giving
equity ownership to managerial shareholders will improve financial performance of firm
(Hashim & Hameed, 2012; Qureshi et al., 2010).

Pound, (1988) analyzed institutional ownership and its effects on financial performance of the
firm and proposed that Efficient Monitoring hypothesis enhances financial performance of the
firm. Berle and Means, (1991) suggested that institutional shareholdings reduce cost of
transaction as well as it removes agency problem to a great extent. Hermalin and Weisbach
(2001) identified that more improvement in profitability is achieved by firms with more

16
independent directors, which in turn enhance financial performance of firm. Javed and Iqbal,
(2006) conducted a study to appraise corporate governance and financial performance of fifty
non financial firms, including more than 80% of market capitalization listed at Karachi Stock
Exchange, Pakistan. They conclude that there is a positive and significant relationship between
corporate governance and financial performance of firms. Good corporate governance leads to
sound financial performance (Drobetz, Shillhofer & Zimmermann, 2003; Hashim, 2013).

The core purpose of this research is to evaluate the impact of corporate governance on financial
performance of cement sector firms listed on PSX and suggests measures to improve corporate
governance practices to maximize financial performance.

Chugh, Meador & Kumar (2011) found that a larger board size creates more opportunities and
resources for better financial performance. According to Ibrahim, Rehman and Raoof (2010)
there is a negative correlation of ROA with board size. Coleman (2007) derived that large board
size enhances corporate performance .Cheng Wu, Chiang Lin; I-Cheng &Feng Lai (2005)
concluded that board size is significantly and negatively related to firm performance Cheng
Wu,Chiang Lin, I-Cheng &Feng Lai (2005) found that board composition is positively and
significantly related to firm performance. Javid&Iqbal (2008) in their study concluded that the
Board composition has positive & significant impact on firm performance.

According to Yasser, Entebang&Mansor (2011) there is a no significant relationship between

ROA and CEO / chairman duality. Chaghadari (2011) in the results of his study provided the
evidence that the CEO duality has a negative impact on ROA. In simple words, CEO duality is
found to decrease the effectiveness of the board of directors. Chugh, Meador & Kumar (2011)
investigated that CEO duality is negatively correlated by firm performance. According to
Coleman (2007) resulted that CEO duality has a negative effect on profitability and suggested to
separate the position of CEO and chairman chair. Cheng Wu, Chiang Lin, I-Cheng &Feng Lai
(2005) concluded that CEO duality is negatively and significantly related to firm performance.

Lam and Lee (2012) examined that board composition is positively (negatively) related to firm
performance. Such positive or negative relationship depends on the independence or non-
independence of the composition of board. Ceo/chairman duality is negatively related to firm
performance.

Ujunwa (2012)by using panel data regression model drive that board size, ceo/chairman duality
was negatively related with firm performance, whereas board independence have positive impact

17
on firm performance. Corporate governance and board research have mainly been influenced by
agency theory, stewardship theory and resource dependency theory Ponnu (2008) concluded that
impact of CEO Duality and proportion of independent directors on company performance has
received close attention by researchers in corporate governance in recent years it was found that
there is no significant relationship between duality and board independence to company
performance

According to Coleman & bike pee (2006) board size is positively related to ROA but negatively
related to sales growth rate as performance variables. The size of the board is on various
performance measures though insignificant and surprisingly the board composition has a
negative impact on firms’ performance in Ghana Board composition also plays a significant role
in shaping the corporate value system of any corporation. Jones and Goldberg (1982), Even and
Freeman, (1983) Leuma and Goodstein, (1997) explicitly described in their research articles that
the companies that separate ownership and control, the responsibility for defining and changing
corporate values is often effectively left to the management. Relationship with critical
stakeholders may be internalized by having them represented on the board as non-executive
members. Board members may effectively represent different ownership groups (for example
founding families, large block holders or Institutional Investors as well as owner managers). In
some countries employees or governments are entitle to board representation. But owners may
also voluntarily choose to appoint members with links to stakeholders groups (e.g. the financial
community or research institutions) that are believed to be important to firm growth or survival.

Steiner (1996); Han and Suk (1998) and Woidtke (2002) stated that the ownership decision
allocates ownership rights across the relevant parties, i.e. the company’s present and potential
owners. This is a matching problem in which potential owners with specific characteristics are
matched with firms, which have their own specific characteristics. Hart, (1995) and Hansmann,
(1996) further elaborated that the owner characteristics include access to information, capital and
knowledge and for given firm characteristics, the economic theory of corporate ownership
predicts that the ownership will be allocated to minimize transaction costs. But regardless of the
actual determinants, ownership has material consequences for the values and behavior of the
firm.

Theoretical frame work

18
Board Size

Firm Performance> ROA

Board Composition

CEO/ Chairman Duality

19
Chapter 3

Methodology

There are 83 companies working in Pakistan presently. But the data was available for only 12
companies, so researcher chose these companies as a sample for research.

The Data on; board size, board composition, duality and ROA, needed for this research is
collected from the annual reports of the companies for six years, from 2005 to 2010. And the
calculated ROA is taken from the Basic Balance Sheet Analysis issued by the State Bank of
Pakistan.

Model
A panel data approach is used for this research because, according to Himmelberg (1999), it
facilitates removal of the unobservable heterogeneity that may exist in the different firms.
Yasser (2011) concluded that, the first advantage of the panel data regression is this that by
combining the time series and cross section observation panel data provides better informative
data, less co-linearity among the variable and more efficiency. And secondly, panel data
minimizes the biasness that may be caused if separate firm level data are divided into broad
aggregates. And finally, panel data can measure the effects that are not possible to observe in
pure cross section or pure time series data.

This research is made for the purpose of evaluating the effect of corporate governance on firm
performance while examining the sugar industry of the Pakistan. The Models are as under:

ROA=a+b1(BS)+b2(BC)+b3(Duality+e

Where:

ROA = Return on Asset

BS= Board Size

BC= Board Composition

Duality= CEO and Chairman Duality

E= Error

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21
Explanation of Variables

Variable Definition

Independent variable

Board Size The total number of directors in the firm.

It shows the number of executive directors and number of non-

Board Composition executive directors.

It indicates that either the post of CEO and Chairman are being held
Duality by the same
person or by two different persons.

Dependent Variable

ROA Return on Assets. Calculated by Net Income divided by Total Assets.

(a) Board Size

In a large board size there is a problem of communication between board members, quick
decision making could not possible, which causes great detriment to firm performance
.Yermack (1996). According to Eisenberg et al. (1998) and Singh and Davidson (2003), board
size has a negative relation with firm performance. , this article proposes the hypotheses as
follows.

Ho：b1=0

Board size has no effect on ROA

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Ha: b1 ≠ 0

Board size has some effect on ROA

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(b) Board composition

In this research board composition is an independent variable. Independent directors are required
on the board to control the activities of executive directors due to their opportunistic behavior,
and make a check and balance on the board (Jensen &Meckling, 1976). Independent directors
are considered as “decision experts” (Fama& Jensen, 1983). Non-executive directors can reduce
managerial consumption (Brickley& James, 1987). Non-executives directors act as middleman
between company and external stake holders. According to the Tricker (1984) the of non-
executive directors on Boards provides “additional windows on the world” According to
Pakistani Code of corporate governance (2002) boards of directors must have the proportion of
executive directors must not exceed 75%.

Ho：b2=0

Board composition does not affect ROA

Ha: b2 ≠ 0

Board size may be taken as causal factor of ROA

(c) Duality

The board of directors can lose its independence and monitoring power when the chairman is
working as a decision-maker as well as also as a supervisor and consequently performance is
being affected in a negative way. It is attested by the Bally and Dalton (1993), Bahya (1996) that
CEO duality deteriorates firm performance. So following the above stated attestation we
proposed the hypotheses as under:

Ho：b3=0

Ceo/chairman duality has no impact on ROA

Ha: b3 ≠ 0

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Ceo/chairman duality has some impact on ROA

25
Chapter 4

Results:

Table 1. Descriptive Statistics

N Mean Std. Deviation

Size 72 26.25 13.960

Bcom 72 20.83 8.681

Duality 72 .42 .496

ROA 72 6.25 14.274

Valid N (list wise) 72

The results have shown that he mean of board size, board composition and Duality, independent
Variables, is 26.25, 20.83, and 0.42 respectively. And the Standard Deviation is 13.960 for
board size, 8.681 for board composition and for duality standard deviation is 0.496. On the other
hand the mean of dependent variable ROA (Return on Assets) is 6.25 and 14.274 is standard
deviation for Return on assets.

Table 2. ANOVAb

Sum of Mean
Model Squares df Square F Sig.

26
 1 Regression 3480.350 3 1160.117 7.642 .000a

Residual 10322.619 68 151.803

Total 13802.969 71

a. Predictors: (Constant), Duality, Size, BCom

b. Dependent Variable: ROA

Table 3. Model Summary

Adjusted R Std. Error of

Model R R Square Square the Estimate

1 .506(a) .256 .223 12.58046

a. Predictors: (Constant), duality, size, comp

Results of table 2 research show that all the independent variables have highly significant impact
on ROA. As it is significant at .000 which shows collectively Board size, Board Composition,
CEO/Chairman Duality have significant impact on firm performance. Results of table 3 show
the value of coefficient of determination which is 25.6%. Its means that 25.6% change in ROA is
due to change in corporate governance mechanisms.

Table 4. Coefficientsa

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 Standardized
Unstandardized Coefficients Coefficients

Model B Std. Error Beta t Sig.

1 (Constant) 2.189 5.650 .387 .700

Size .245 .112 .246 2.189 .032

BCom .073 .194 .045 .375 .709

Duality -9.539 3.427 -.340 -2.784 .007

a. Dependent Variable: ROA

Results of table 3 show that board size has some significant impact on ROA. As it is significant
at .032 which shows that it has a significant impact on firm performance. Unitary change in
board size will bring change in ROA by 0.245 These results are in line with(Mollah, Al
Farooque, & Karim, 2012). Board composition has insignificant impact on firm performance
which is being measured by ROA. Board composition has insignificant impact on firm
performance. It explains that when more independent directors sit on the board, the firm’s
performance decreases. Thus, companies do not fully utilize the roles of the independent
directors. The directors may sit on the board to fulfill the board composition requirements or to
show that the board is “independent”, but in reality it is not CEO/Chairman Duality has a
significant impact on ROA it is significant at .007 which shows that CEO/Chairman Duality has
an impact on firm performance. tcal for Board Size, Board Composition, and CEO/Chairman
Duality is respectively as 2.189, .375, and 2.784 . This means that in family firms when chair of
ceo and chairman is held by same person performance of firm will increase these results
supports by Yasser, Entebang, and Mansor (2011) (Lam & Lee, 2012).

Conclusion

28
Corporate governance is now a global issue. The first code of Corporate Governance in Pakistan
was issued in March 2002 by Security and Exchange Commission Pakistan (SECP).SECP
established an institution for corporate governance in2004. This research conducted to evaluate
the effect of corporate governance on firm performance in Pakistan. For this purpose we chose
sugar sector in Pakistan to cheek the impact of CG on firm performance. CG measured by ROA.

As the results shows that CG has significant impact on firm performance. Board size has
significant impact on firm performance, Board Composition has an insignificant impact on ROA
and CEO/Chairman Duality has a significant impact on ROA. And collectively all independent
variables have significant impact on CG.

Limitation of the Study

For the purpose of this study we have chosen 12 sugar companies of Pakistan out of total of 84
sugar companies because of the reason that the data needed for the purpose of this research was
not available for most of the companies.

Recommendations:

• Code of corporate governance should be followed.

• There should be an optimal board size say, seven directors on board

• Board should have a composition of Executive and non-executive directors

• CEO and chairman’s chair should be separate

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30
References

“Basic Balance Sheet Analysis” issued by the State bank of Pakistan.

Abidin, kamal, Jusoff, 2011, “Board Structure and Corporate Performance in Malaysia”.
International Journal of Economics and Fianance.

Annual Reports Issued by the Companies.

Biekpe, “The Relationship between Board Size, Board Composition, CEO Duality and Firm
Performance:

Experience from Ghana.”

Cheng Wu, Chiang Lin, cheng, Feng Lai, “The Effects of Corporate Governance on Firm
Performance”.

Dar, Naseem, Rehman, Niazi, 2011, “Corporate Governance and Firm Performance a Case
Study of Pakistan Oil and Gas Companies Listed in Karachi Stock Exchange”. Global Journal of
Management and Business Research.

Friday, Godwin, Paul, 2011, “Board composition and Corporate Performance: An analysis of
Evidence from Nigeria”.

Research Journal of Finance and Accounting.

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Ibrahim, Rehman, Raoof, 2010, “Role of Corporate Governance in Firm Performance: A
Comparative Study between Chemical and Pharmaceutical Sectors of Pakistan”. International
Research Journal of Finance and Economics.

Javid, Iqbal, 2008, “Does Corporate Governance Affect a Firm’s Performance? A Case Study
Pakistani Market.” NUST Journal of Business and Economics.

Lam, T. Y., & Lee, S. K. (2012). Family ownership, board committees and firm performance:
evidence from Hong Kong. Corporate Governance, 12(3), 6-6.

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