Corporate governance mechanisms and firm performance: empirical evidence from medium and large-scale manufacturing firms in Ethiopia

• DOI: https://doi.org/10.1108/CG-11-2020-0527
• Published date: 23 September 2021
• Date: 23 September 2021
• Pages: 213-242
• Subject Matter: Strategy,Corporate governance
• Author: Obsa Teferi Erena,Mesfin Mala Kalko,Sara Adugna Debele

Corporate governance mechanisms and

firm performance: empirical evidence

from medium and large-scale

manufacturing firms in Ethiopia

Obsa Teferi Erena, Mesfin Mala Kalko and Sara Adugna Debele

Abstract

Purpose –This study aimsto examine the impact of corporate governancemechanisms on financial and

non-financialaspects of firm performance in mediumand large-scale manufacturingfirms in Ethiopia.

Design/methodology/approach –The cross-sectional survey and simple random sampling methods

are adopted while the datacollection is through a questionnaire that coversfive corporate governance

indicators consisting of the boardindependence, board effectiveness, shareholders role,internal audit

effectiveness (IAE) and disclosure and transparency. The dimensions of firm performance were

indicated by six firm performance indicators of customer and market (CM), internal process (IP),

differentiation,efficiency, competitive position (CP)and financial (organizational) performance(OP). The

covariance-basedstructural equation modeling(SEM) with the maximum likelihood parameter estimation

techniquewas used to perform the data analysis.

Findings –A significant positiverelationship has been found between the independenceof the board of

directors and firm performance(especially with respect to differentiation, OP, CP and IP). However,the

board of directors’ effectiveness showed an unexpected result, significant negative effect on

differentiation,OP, CP, CM and IP. The study also indicatesa positive significant effect of disclosureand

transparency on differentiation, CP and OP. However, the coefficient on the CM construct of firm

performance is negativeand significant. A significantnegative linkage has also been revealed between

IAE and two constructsof performance: differentiation and CP. One of theimportant findings of the study

is that shareholders’ role has a significant positive impact on both board characteristics (board

independenceand board effectiveness) and firm performance(differentiation, efficiency,CP andOP).

Research limitations/implications –The study has two potential limitations. First, in comparison to

prior studies, this studyis based on a small sample size which limits the generalizability of the findings.

Different scholars have suggested (Anderson and Gerbing, 1984, 1988; Iacobucci, 2010; Hair et al.,

2019) that SEM requires a large sample size to test the hypothetical model. Thus, future research can

furtherinvestigate the link between corporategovernance and firm performanceby using a larger sample

size to achieve more reliableresults. Second, the current study used a quantitativeapproach only, but

prior studies (e.g. Ahrens and Khalifa, 2013) suggest a qualitative approach to more investigate and

reach a very conclusive idea on corporate governance. The approach is currently receiving growing

popularityin the literature.

Practical implications –The findings of the study would have measurable implications for different

stakeholders who are in the position of supporting or regulating manufacturing firms.First, the findings

give a clue abouthow a firm can design a good corporate governancesystem. Second, managers of the

firm can get a hint or tip fromthe result that might help as input for designing strategies. Finally, it might

help policymakers to understand and think about the very crucial role of active participation of

shareholders in curtailing/reducing agency cost and enhancing firm performance apart from (beyond)

the conventional corporate governance mechanisms (board of directors,internal audit, disclosure and

transparency).

Originality/value –This study seeks to extend and contribute to the current literature in several ways.

First, in contrast to previous studies, this study used both financial and non-financial performance

Obsa Teferi Erena is based

at the College of Business

and Economics, Hawassa

University, Hawassa,

Ethiopia. Mesfin Mala Kalko

is based at the Faculty of

Management and

Economics, Tomas Bata

University in Zlin, Zlin,

Czech Republic.

Sara Adugna Debele is

based at the College of

Business and Economics,

Hawassa University,

Hawassa, Ethiopia.

Received 8 December 2020

Revised 13 April 2021

29 July 2021

Accepted 15 August 2021

The authors gratefully

acknowledge the financial

support for this study from

Hawassa University and Tomas

Bata University in Zlin (IGA/

FaME/2020/003). The authors

would also like to thank prof.

Gabriel Eweje (Editor-in-Chief),

Dr Yan Wang (Associate Editor)

and two anonymous reviewers

for their time and effort devoted

to critical review, helpful and

constructive comments.

Competing interests: On behalf

of all authors, the

corresponding author states

that there is no conflict of

interest.

DOI 10.1108/CG-11-2020-0527 VOL. 22 NO. 2 2022, pp. 213-242, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 213

measures and thereby providing new empirical insights relating to the non-financial performance

measures. Second,this study provides a new result that the role of shareholdershas a direct significant

positive impact on board characteristics (i.e. board independence and board effectiveness) and firm

performance. Finally,this study has come with a new insight that disclosureand transparency is a major

driver of firmperformance.

Keywords Corporate governance, Structural equation modeling, Ethiopia, Firm performance,

Manufacturing firms

Paper type Research paper

1. Introduction

Developing countries, such as Ethiopia, are often faced with a multitude of problems such

as the absence of an organized stock market, lack of shareholders’ active involvement in

corporate governance issues/disputes, frequent government intervention, weak institutional

capacity to encourage/promoteand facilitate compliance with corporate governance codes

and a weak regulatory environment (Tsamenyi et al.,2007;Herath and Freeman, 2012;

Ayele, 2013). Dato et al. (2018) indicated that the legal structure of Ethiopia’s corporate

system, and the general level of corporate governance practices, are weak. Tura (2012)

also pointed out that the Ethiopian share company law lacks sufficient statutory guidelines

on governance issues such as the division of oversight and management duties, as well as

the composition, independence and remuneration of the board of directors’ in share

companies. Ayele (2013) also asserts that political parties’ involvement, inadequate

shareholder protection laws, a culture of accepting misgovernance and discrimination in

regulatory rule enforcement between state-owned and private banks are among the

challenges of corporate governance in Ethiopia. Furthermore, internal audit’s role in

corporate governance through itsservices to the board of directors has been ignored in the

manufacturing firms in Ethiopia. Similarly, in the overall score, the World Economic Forum’s

(2019) Global Competitiveness Index report ranked Ethiopia 140th out of 141 economies in

the corporate governance sub-pillar (which includes the strength of auditing and

accounting standards, conflict of interest regulation, and shareholder governance). Prior

studies claim that these structural characteristics, coupled with concentrated ownership

and economic uncertainties (poor economic conditions), demand effective corporate

governance in developing countries (Ahunwan, 2002;Rabelo and Vasconcelos, 2002).

Besides, developing countries need well-established corporate governance practices to

attract foreign direct investment and achieve economic development (Herath and Freeman,

2012).

Corporate governance is defined as a system that deals with the exercise of power over

corporate entities, outlining the structures and processes associated with strategic

decision-making and control within a company(Melis, 2004). It has a variety of role players.

The principal is an internal audit, audit committee, chief executive officer and board of

directors. It is believed that, in a market economy, good corporate governance is crucial for

safeguarding the interests of multiple stakeholders and building investor confidence (Feng

et al., 2017;Lattemann, 2014). Bekele (2012) also asserts that a good corporate

governance framework fosters market integrity, increases economic efficiency and growth,

and enhances investor trust. The role of corporate governance mechanisms in enhancing

firm performance has extensivelybeen studied both in developed and developing countries

(Klein et al.,2005;Cheng et al., 2011;Nordberg and Booth, 2019;Arosa et al.,2013;Zhou

et al., 2018;Lenz et al., 2018;Mihret et al.,2010;Mihret and Yismaw, 2007;Adedeji et al.,

2019). It is very common in empirical studies that corporate governance is usually

represented (measured) by the board of directors’ characteristics, internal audit

effectiveness (IAE), chief executive officer (CEO) duality, audit committee and internal-

external auditor relationship. Given these conventional proxies, in the current study, we

have posited the role of shareholders in corporate governance practices. The corporate

governance practice in developed countries (where there are strong shareholder laws and

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