The impact of board characteristics and ownership identity on agency costs and firm performance: UK evidence

• Date: 03 December 2018
• Pages: 1147-1176
• Published date: 03 December 2018
• DOI: https://doi.org/10.1108/CG-09-2016-0184
• Author: Bahaaeldin Samir Allam
• Subject Matter: Strategy,Corporate governance

The impact of board characteristics

and ownership identity on agency costs

and firm performance: UK evidence

Bahaaeldin Samir Allam

Abstract

Purpose –This paper aims to providea twofold empirical comparison: first, a comparison betweenthe

impact of corporategovernance mechanisms on agency costs proxiesand firm performance measures,

and second, this comparisonwas used before and after the 2008 financial crisis, capturing two different

economicstates.

Design/methodology/approach –Panel regression methods were applied to two data sets of non-

financialfirms incorporated in the FTSE ALL-Shareindex over the period 2005-2011.

Findings –The results provide evidencethat not all mechanisms lead to lower agency conflicts and/or

higher firm performance. Ownership identity has a significant impact and the role of the governance

mechanismschanges with the changes in the economicconditions surrounding thefirm.

Research limitations/implications –The resultslend support to the notionthat forcing a certaincode of

practiceon firms to followcould compel themto move away from conflictreductiongovernance structures.

Originality/value –To the best of the authors’ knowledge, this is the first paper to provide a comparison of

empirical evidence for the impact of board characteristics and ownership identity on agency costs and firm

performance by using a comprehensive set of corporate governance mechanisms. This comparison

challenges the prior studies that use performance as an indirect proxy for lower agency costs. Additionally, it

compares the impact of the governance mechanisms during two differenteconomic conditions.

Keywords Corporate governance, Agency theory, Resource dependence theory,

Stewardship theory, Block holding, Block holder identity, Managerial ownership, Agency costs,

Firm performance, Firm value, Financial crisis, Endogeneity

Paper type Research paper

1. Introduction

The term “corporate governance” always attracts the attention of large investors, practitioners

and regulators, especially after accounting scandals and financial crises. Investors blame

regulators that they did not enact the proper regulations to protect their wealth from

management fraud, and practitioners support these claims. Regulators respond by introducing

stricter governance code. After the 2008 financial crisis, The International Corporate Governance

Network issued a statement introducing corporate governance as the cause and the solution of

the crisis. Strengthening boards was one of the underscored issues that should be improved to

avoid any future crises (ICGN, 2008). Likewise, Kirkpatrick (2009) concluded that the

Organisation for Economic Co-operation and Development corporate governance principles

need to be revised to identify whether there is a need for more guidelines and/or clarifications.

However, prior literature and real-life examples provide no evidence that strict regulations would

lead to better performance or avoid any future fraud or scandals.

Originally, corporate governance mechanisms are introduced to alleviate the negative

consequences –mainly agencyconflicts and the costs resulting from these conflicts –of the

Bahaaeldin Samir Allam is a

Lecturer in Finance at the

Business Administration

Department, Cairo

University, Faculty of

Commerce, Giza, Egypt.

JEL classification –G34, G30,

G01

Received 15 September 2016

Revised 30 January 2018

29 March 2018

Accepted 21 May 2018

DOI 10.1108/CG-09-2016-0184 VOL. 18 NO. 6 2018, pp. 1147-1176, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1147

separation between ownership and control. However, most of the prior studies (Ujunwa,

2012;Yang and Zhao, 2014;Arora and Sharma, 2016;Mishra and Kapil, 2017;Bhatt and

Bhatt, 2017 among others) were directed to investigate the impact of these mechanisms on

enhancing firm performance and value as indirect proxies of lower agency costs. The

reported results of this researchstream failed in providing systematic and consistent results

that can shape an optimal governancestructure. Moreover, only a limited number of studies

(Ang et al.,2000;Singh and Davidson, 2003;McKnight and Weir, 2009;Belghitarand Clark,

2015;Garanina and Kaikova, 2016), among others) have investigated the role of

governance mechanisms on agency costs proxies. Nonetheless, these studies used a

limited number of governance mechanisms; most of these studies were applied to other

contexts different from the UK context. Even the UK studies used small and old data sets

(Belghitar and Clark, 2015) cover the period of 2000-2004 and mainly examine the

compensation structure as agencycosts mitigating mechanism).

The most common limitations of these studies are their analysis techniques. Renders et al.

(2010) mention that a common issue with prior studies is that they suffer from econometric

problems such as endogeneity and/or the lack of the statistical power. Moreover, each firm

could design their governance structure that maximises shareholders’ wealth and fits with

firm’s specific characteristics (Renders et al.,2010). Similarly, Brown et al. (2011) mention

that prior studies used ordinary least squares (OLS),ignoring the endogeneity problem and

that the examined models could suffer from unobserved heterogeneity, which means that

the identified relations result from unobserved factors. Thus, this study uses panel data

regression models, instead of OLS, to overcome this limitation. Additionally, this study

considered the endogeneity problem by identifying the endogenous variables before using

instrumental variable regression two-stage least square (2SLS) methods; these points

together could provide more accurateand unbiased results.

It is widely argued in the governance literature that the institutional settings and the

regulatory framework have a significant impact on the governance structure chosen by

the firm. Considering that the UK governance structure is characterised by “comply or

explain” feature, all listed firms should disclose their compliance with the governance

code. Thus, based on our sample that shows a high compliance with the code

recommendations, it is plausible to claim that the UK context is well governed and lower

agency costs should be expected. Having said that, Belghitar and Clark (2015) mention

that UK studies failed to provide solid evidence that corporate governance

mechanisms reduce agency costs.

Van Essen et al. (2013) provide evidencethat governance mechanisms that are assumed to

boost firm performance during the steady state have an adverse impact during the crisis

conditions (and vice versa). Thus, this paper investigates the impact of a comprehensive

set of corporate governance mechanisms on reducing agency costs, enhancing firm

performance and maximising shareholders’ wealth in the UK context.Also, it conducts such

investigation during two different economic states (before and after the 2008 financial

crisis). These analyses add to the current argument about governance mechanisms

effectiveness and provide evidence suggesting that not all mechanisms introduced by

academics, practitioners andregulators reduce agency costs and/or improve performance;

they also provide evidence that theireffectiveness is constrained by the country’s economic

state and how the market perceives such mechanisms.

This paper challenges prior studies (Demsetz and Villalonga, 2001;Brown and Caylor,

2004;De Miguel et al., 2004;Beiner et al.,2006;Brown and Caylor, 2009 among others)

that use performance proxies as indirectmeasures of lower agency conflicts. Nicholson and

Kiel (2007) assert that firms can report high level of profit even in the presence of agency

costs. Wiwattanakantang (2001) states that accounting and market performance measures

do not reflect all agencycosts.

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