The governance role of shareholders and board of directors on firm performance: an eclectic governance-performance model

• DOI: https://doi.org/10.1108/IJAIM-10-2020-0172
• Published date: 13 August 2021
• Date: 13 August 2021
• Pages: 493-527
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Ozgur Ozdemir,Erhan Kilincarslan

The governance role of

shareholders and board of directors

on f‌irm performance: an eclectic

governance-performance model

Ozgur Ozdemir

Birkbeck University of London, London, UK, and

Erhan Kilincarslan

Department of Accounting, Finance and Economics,

University of Huddersf‌ield, Huddersf‌ield, UK

Abstract

Purpose –This study aims to examine the governance role of shareholders and board of directors in

determining f‌irm performance through an eclectic multi-theoretic model that integrates structure and

incentivefunctions of agency theory and capability aspectof the resource-based view.

Design/methodology/approach –The research model uses a large panel data set of 2,364 UK f‌irms

over the period2000–2010 and uses alternative specif‌icationsof the model to improve robustness.

Findings –The results show that theindustry experience of major shareholders as a proxy for shareholder

capability has a signif‌icant positive impacton investee f‌irm performance. The f‌indings alsoreveal that the

lock-in effect of the largest shareholder has a positive impact on performance, whereas the monitoring

effectiveness of shareholders is not associated with ownership concentration. Moreover, the results indicate

the underlying capabilitiesof the board of directors and their impact on corporate performance –particularly,

the interlocking directorates of executives have a positive impact on f‌irm performance but those of non-

executives have a negative one. However, the previous directorship experience of non-executives has a

positiveimpact on performance.

Research limitations/implications –This study presents a more comprehensive and complete

understanding of the governance-performance relationshipbeyond the narrowor partial explanationsprovided

by single-theory-basedstudies orthose of investigatingthe effect ofvarious governancetools separately.

Practical implications –This study provides more insights into the capability dimension of

shareholders and the role of incentives in motivating shareholders to exercise stronger oversight on the

managementrather than just using ownership concentration.Hence, the study can serve as valuable guidance

for investors,corporate managers and policymakers.

Originality/value –Tothebestoftheknowledge,thisisthef‌irst comprehensive study that uses an eclectic

philosophical approach, integrating the agency theory and resource-basedview, to not only examine the impact

of board of directors but also investigate the governance role of shareholders in modern corporations to

understand how shareholders acquire the requisite skills and information, the best practices and processes, and

ultimately use the scarce and inimitable resources that help investee f‌irmsin improv ingtheir p erformance.

Keywords Resource-based view, Agency theory, UK f‌irms, Governance-performance model

Paper type Research paper

This research is extracted and extended from a part of the doctoral thesis, which was written by

Ozgur Ozdemir at Birbeck College, University of London. This research did not receive any specif‌ic

grant from funding agencies in the public, commercial, or not-for-prof‌it sectors.

Governance role

of shareholders

and board of

directors

493

Received24 October 2020

Revised6 January 2021

9April 2021

20May 2021

Accepted22 May 2021

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 4, 2021

pp. 493-527

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-10-2020-0172

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

1. Introduction

The relationship between corporate governance and f‌inancial performance has been

extensively investigated in different disciplines (e.g. economics, f‌inance, management, law

and sociology) by numerous researchers (McConnell and Servaes, 1990;Wahal, 1996;

Filatotchev et al., 2001;Gompers et al.,2003;Mangena et al., 2012;Peni and Sami, 2012;

Singh et al., 2018). This is because the separation of ownership and control especially in

widely-held modern corporations creates a space for potential conf‌licts of interest between

shareholders and management (Berle and Means, 1932;Alchian and Demsetz, 1972;Jensen

and Meckling, 1976). Given that shareholdershire managers to run the f‌irm on their behalf;

theoretically, corporatemanagers are assumed to perform primarily to maximise the wealth

of their shareholders (Ward, 1993;Bishop et al., 2000). In practice, however, the actual

behaviour of these managers can have an important impact on f‌irm performance, and thus

market value –whether they act in the best interests of shareholders or abuse their

controlling power at the expense of shareholders’interests. As corporate governancerefers

to the ways in which company owners attempt to assure themselves of earning a return on

their investment (Fama and Jensen, 1983;Shleifer and Vishny, 1997), it is, therefore,

suggested that an effective governance framework can help mitigate the problems

associated with the separation of ownership and control by reducing opportunistic

behaviour of managers,and hence increasing f‌irm performance and value.

Previous research investigating the shareholder-management relation generally follows

two dominant paths: the agency theory and the resource-basedview of the f‌irm. In fact, the

mainstream is grounded on an agency theoryperspective that often focusses on monitoring

functions (e.g. board of directorsand ownership concentration) and incentive mechanisms (e.

g. managerial ownership and performance-based remuneration) to align the interests of

management with those of shareholders. Such alignment leads to good internalgovernance

and decreases agency problems, therefore, improves f‌irm performance (Demsetz and

Villalonga, 2001;Filatotchevet al.,2001;Chen et al., 2008;Lin et al.,2009).

The second research stream is driven by the resource-based view of strategic

management. This resource-basedview aims to provide an association between the board of

directors and corporate performance through directors’perceived ability to reduce

environmental uncertainty–the external linkages of directors connect their f‌irms to a wider

environment and other f‌irms in the marketand supply access to potential business partners,

production facilities and investments(Barney, 1986;Dierickx and Cool, 1989;Peteraf, 1993;

Mahoney and Pandian, 1992).However, it is argued that none of these theories fully explains

the determinants of effective corporate governance or the association between governance

and performance single-handedly. For instance, the control focus of the agency theory

ignores boards’abilityto monitor and the ability to focus on the resource-based view ignores

the role of incentives in ensuring good corporate governance. Thus, each theory provides a

partial explanation(Nicholson and Kiel, 2007;Jackling and Johl, 2009).

Another important issue with the extant corporate governance studies using both the

agency and resource-based views is that they mostly ignore the underlying capabilities of

shareholders, as well as neglecting the incentives for shareholders in determining good

governance (Richardson, 1972;Granovetter, 1985;Perrow, 1988;Hillman and Dalziel, 2003).

In identifying shareholders’role, the vast majority of research has generally focussedon the

ownership concentration (De Miguel et al.,2004;Mura, 2007;Chang et al.,2008;Lin et al.,

2009) and suggested that large block outside ownership has a counter-balancing effect on

managerial opportunism (Filatotchev et al., 2001). Nevertheless, ownership proportion alone

cannot capture such things as shareholderknowledge, experience and skills, despite the fact

that shareholders can accumulate knowledge and skills through their investments in the

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market (Douma et al., 2006;Chuang and Wu, 2011) and ultimately improve the f‌irm’s

performance. Yet, ownership concentration is not a suff‌icient proxy measuring the

incentives for shareholdersdue to the factors such as the emergence of cross-shareholdings,

in which case the impact of incentives has been for shareholders to better monitor the

individual f‌irms (Maug, 1998;Thomsen and Pedersen, 2000) and the fact that ownership

mindset is determined through a value maximising approach driven by portfolio structure

(Lskavyan and Spatareanu, 2006). Given that the motivation of agency explanation on

control and the information and the focus of the resource-based view on ability and

resourcing are not mutually exclusive, it is recommended that the agency theory should be

coupled with complementary approaches to provide a better empirical perspective

(Eisenhardt, 1989). Similarly, Hillman and Dalziel (2003) emphasise the importance of

integrating these two dominant theories for a better explanation of the governance-

performance association because integration overcomes current myopia in the two

dominant theories.

Accordingly, we aim to examine the governance role of shareholders and board of

directors on f‌irm performance through an eclectic multi-theoretic model that is designed to

supply a more comprehensive understanding of their impact in determining corporate

performance, and hence to contribute new evidence beyond the narrow or partial

explanations provided by the existing research. In particular, our eclectic analytical

governance-performancemodel assumes; good governance is a function of shareholdersand

board of directors, integrates the dominant agency theory and resource-based view and

considers such factors regarding structure and incentive (agency theory) and capability

(resource-based view) aspects of shareholders and board of directors affecting governance,

and thus performance in widely-heldmodern corporations. Furthermore, we empiricallytest

our research model using a large panel data set over the period of 2000–2010. Our research

sample has 2,364 non-f‌inancialf‌irms listed on the London Stock Exchange (LSE) and covers

both international large f‌irms listed in the main market (MAIN) and small and growing

f‌irms listed on the alternativeinvestment market (AIM).

Our study contributes to the corporate governance literature in several ways. Firstly, we

extend the existing agency-based empirical research that solely relies on monitoring of

the management by including incentive focus of the agency argument, as well as incorporating

the resource-based view on both shareholders and board of directors. This eclectic approach of

integrating the two dominant theories augments the current incomplete explanations supplied

by single-theory studies. Secondly, although shareholders are the ultimate owners and receive

the outputs of f‌irms which are created by managerial actions, their governance role beyond a

monitoring rationale is not suff‌iciently examined –hence, the extant literature lacks

shareholders’actual impact in determining f‌irm performance. In this respect, using a resource-

based-explanation perspective, we attempt to gain more insights into the capability dimension

of shareholders and the ways how they can accumulate the knowledge and experience needed

to exchange views and information on strategy and performance. Thirdly, by using the lock-in

effect (i.e. the fraction of a given equity investment value to the shareholder’s overall portfolio),

our study provides a better understanding of the role of incentives in motivating shareholders

to exercise stronger oversight on the management. This is because the existing governance-

performance models are biased, as using ownership concentration does not increase

understanding of the impact of shareholders’portfolio characteristics as incentives for better

monitoring due to the emergence of large f‌inancial institutions that invest across numerous

equities. Thus, we argue that the lock-in effect provides a better incentive for a shareholder to

monitor than a traditional f‌irm-level ownership concentration. To the best of our knowledge,

this is the f‌irst comprehensive study that uses an eclectic philosophical approach, integrating

Governance role

of shareholders

and board of

directors

495