Quality of Corporate Governance: A Review from the Literature

Abstract

The purpose of this paper is to review the quality of corporate governance from the prior empirical literature. This study finds that most of the researchers developed the self structured corporate governance index and few researchers used the corporate governance index provided by rating agencies. This study also finds that there is no uniform basis to measure the corporate governance quality and observed the variation in terms of overall and individual attributes of corporate governance; sub-indices of corporate governance; scoring system; weighted and un-weighted method; statistical method; time period; financial and non financial companies; code of corporate governance; listing requirement; disclosure practices; legal environment; firms characteristics; and country perspective. This study also observed that overall corporate governance quality is very low in most of the studies and even quality of corporate governance varies in the firms within the same country. This study recommends that the boundary of corporate governance quality should be defined based on the agreed set of rules and regulation, code of governance and practices. This study also suggests that the regulator and policy makers should more emphasize on code of corporate governance and regulatory framework and monitoring to improve the quality of corporate governance.

1. Introduction

Corporate governance is an emerging issue in an academic research because of chain of financial scandals worldwide (Turrent & Ariza, 2016) and various corporate scandals such as Enron and Andersen in US and Marconi in UK (Khanchel, 2007). The demand of effective corporate governance increases because corporate governance ensures better monitoring and meet the company’s objective or shareholders demand of value maximization and interest of other stakeholders. Quality of corporate governance scrutinizes the transparency and accountability of the firm’s governance related issues and helps to assess whether the firm is better or poorly governed. In addition, academics, practitioners and regulators and monitoring authorities emphasized on corporate governance quality, measured by corporate governance rating or benchmarking, and which is used as an instrument to identify or predict the determinants of success or failure (Lazarides et al., 2008; Lazarides & Drimpetas, 2011). Shareholders, investors, and advisors are interested to know the practices and compliance of corporate governance other than financial position and performance and market players increase the demand of corporate governance rating as it works as a reliable source of information for decision making (Ariff et al., 2007).

The purpose of this paper is to review the quality of corporate governance from the prior empirical literature. The empirical literature on corporate governance quality are mainly based on US (Khanchel, 2007; Silveira et al., 2009;Turrent & Ariza, 2016), UK (Barucci & Falini, 2005; Beiner et al., 2006; Lazarides & Drimpetas, 2011), Canada (Gordon et al., 2012), Africa (Waweru, 2014a,b), Korea (Black et al., 2006); Bangladesh (Biswas, 2012) and cross country studies (Klapper & Love, 2004; Durnev & Kim, 2005;Tchuigoua, 2015).

2. Quality of Corporate GovernanceMeasurement and Analysis

Corporate governance quality is defined as code of governance, rules, regulation, and best practices related to governance and developed to assess whether best governed or worst governed firms. Corporate governance is a system used to direct and monitor the firms (Cadbury committee, 1992). The measurement and analysis of corporate governance quality of the previous empirical literature are explained below:

2.1. Klapper and Love (2004) Study

Klapper and Love (2004) study examined corporate governance quality using total 374 firms of 14 emerging markets such as pazil, Chile, Hong Kong, India, Indonesia, Korea, Malaysia, Pakistan, Philippines, Singapore, South Africa, Taiwan, Thailand and Turkey in 2010. The sample includes 58% firms from East Asia, 19% firms from South Asia and 11% firms from Latin America. They considered total 57 qualitative questions that have binary yes or no answer to measure the corporate governance quality through corporate governance ranking. The questions covered six poad categories such as management discipline, transparency, independence, accountability, responsibility, fairness from Credit Lyonnais Securities Asia (CLSA).

The descriptive statistics presents that the average mean of corporate governance index is 54.11 and ranges from 11.77 to 92.77 with a standard deviation of 14. It is also evident that the mean of corporate governance index 31.85 in Pakistan and 66.53 in South Korea which implies that governance index varies country to country. It is also found that corporate governance index ranges from 17.25 to 66.68 in Pakistan which indicates a larger variation within countries. From the above analysis, they stated that quality of corporate governance varies widely in the sample and the variation is not systematically associated.

2.2. Barucci and Falini (2005) Study

Barucci and Falini (2005) study examined corporate governance quality using 277 companies in 2002 and 275 companies in 2003 from listed financial market of Italian Stock Exchange. They considered composition of board of directors and selection of directors, activity of board of directors and board of auditors as the three attributes of quality corporate governance. The composition of board of directors includes board size, proportion of independent directors, appointment of directors, disclosure of directors profile before appointment, chairman of the board is independent; activity of board of directors includes CEO duality, independence of internal control committee, appointment committee, independence of compensation committee, and defining exclusive power of the board; board of auditors include threshold to present a list to appoint auditors, size of board of auditors is minimum three, and company is controlled by shareholders coalition.

 They find that quality of corporate governance is high in general but quality is low on some points such as power of the board of directors, role of independent directors and director appointment. They also find that chairman is independent in few companies; appointment of directors is not transparent; few companies adopted five members in board of auditors; appointment committee is rare and existence of internal and compensation committee but only few companies have independent committees.

2.3. Durnev and Kim (2005) Study

Durnev and Kim (2005) study investigated the quality of corporate governance practices using total 344 companies of 27 countries. The quality of corporate governance includes composite index, investor protection and social awareness from Credit Lyonnais Securities Asia (CLSA). Composite index is again measured by simple average of six categories of corporate governance (such as discipline (managerial incentives and discipline towards value maximizing actions); transparency (timely and accurate disclosure); independence (board independence);accountability (board accountability); responsibility (enforcement and management accountability) and protection (minority shareholder protection)) of CLSA groups which considers 57 questions that have binary answers yes or no and minimize analysts subjectivity. They also added that protect is the direct measure of investor protection against theft and more relevant to ownership rather than composite index and thus single out protect from six CLSA governance categories.

2.4. Beiner et al. (2006) Study

Beiner et al. (2006) study investigated corporate governance quality using total 109 firms of Swiss Exchange in 2002. Corporate governance index (CGI) is based on survey responses of total 38 questions/attributes, which includes the recommendation of Swiss code of best practice and divided into five sub categories such as corporate governance commitment (5 elements); shareholders’ rights (7 elements); transparency (5 elements); board of directors and executive management (15 elements); reporting and auditing (6 elements). Corporate governance index is measured by assigning a value of minimum 1 and maximum 5 based on the acceptance level of each question and add one point for each subsequent acceptance level on the fivescale answering range and finally compute simple sum of all 38 questions. Corporate governance index is normalized to have a value of between 0 and 100. The higher acceptance level or higher governance index implies that firm is practicing better corporate governance.

The descriptive statistics presents that the average mean of corporate governance index is 58.46 and median is 59.21 which indicates symmetric distribution and ranges from 25 to 90.13 with a standard deviation of 14.34.

2.5. Black et al. (2006) Study

Black et al. (2006) study examined corporate governance quality considering total 453 firms (including 418 small and 35 large firms) of Korean Stock Exchange (KSE) in 2001. The quality of corporate governance is measured by corporate governance index which consider the survey responses of corporate governance practices of Korean Stock Exchange (KSE). Corporate governance index includes total 39 governance elements and divided into five equally weighted subcategories (each category 0-20) such as shareholder rights (5 elements); board structure (4 elements); board procedure (26 elements); disclosure (3 elements); ownership parity (1 element).

The descriptive statistics presents that the average mean of corporate governance index is 29.21 and ranges from 12.73 to 59.33 with a standard deviation of 6.96 for small firms and 51.82 and ranges from 30.22 to 70.55 with a standard deviation of 10.70 for large firms. It is also evident that the average mean of- shareholder rights is 2.99 and 5.6 for small and large firms respectively; board structure is 0.85 for small firms and 14.71 for large firms; board procedure is 8.16 and 11.87 for small and large firms respectively;disclosure subcategory is 0.69 for small firms and 3.24 for large firms and ownership parity is 16.53 and 16.40 for small and large firms respectively.

2.6. Khanchel (2007) Study

Khanchel (2007) study examined corporate governance quality considering total 624 nonfinancial firms of US from 1994 to 2003. Quality of corporate governance index is measured by four poad categories such as board of directors, board committees, audit committee, and overall or total index. Board size, separate chair dummy, outside directors, board meetings are considered to measure board of directors; existence of compensation committee and nominating committee, CEO not on compensation committee and nominating committee and, meetings of compensation committee and nomination committee are considered to measure the compensation and nominating committee i.e. board committee; existence of an audit committee, audit committee size, audit committee meetings, auditor is a BIG 4, members financial expertise are considered to measure audit committee and board of directors, board committee and audit committee jointly measure corporate governance.

He finds that the average mean of board index is 49.92 and ranges from 13.25 to 91.75 with a standard deviation 12.51; the average mean of compensation and nominating committees are 50.19 and minimum 20.83 and maximum 75 with a standard deviation 12.03 and the average of audit index is 51.2 and the minimum and maximum are 6 and 76.4 respectively with a standard deviation 12.98 and the overall mean of total governance index is 50.78 and ranges from 22.78 to 73.61 with a standard deviation of 8.61. He added that firms which exercise the best monitoring systems have the governance index 73.61 and firms which practice the worst governance have the governance index 22.78.

He also mentioned that the problem of corporate governance could not solved by only increasing the corporate governance quality or using the best practices of other firms. Finally, he concluded that a unique governance model should consider the internal strength and relationship based corporate governance process to enhance the corporate governance practices.

2.7. Silveira et al. (2009) Study

Silveira et al. (2009) study examined corporate governance quality considering total 823 firm year observations of 200 financial and non financial firms from listed Sao Paulo Stock Exchange of pazil during 1998 to 2004. Corporate governance index is measured by total 24 objective questions which are collected from publicly available secondary data. If the answer of each question is positive score 1 point otherwise 0 and the total score ranges from 0 to 24 which indicates from lowest to best governance quality. Total 24 objective questions of corporate governance quality are divided into four sub-categories such as: disclosure (6 questions); board structure and operation (6 questions), ethics and conflicts of interest (6 questions) and shareholder rights (6 questions). They used equally weighted method to compute the corporate governance index. They argued that this equally weighted method is less questionable than any other difficult weighting method though it involves subjective evaluation.

The descriptive summary statistics presents corporate governance index (CGI) on a scale of 0 to 10 during 1998 to 2004. It is evident that the average mean of corporate governance index is 4.16 and 5.00 in 1998 and 2004 respectively which indicates the overall quality of corporate governance is poor though it is improving slowly over the year. It is also evident that the average mean of disclosure is 6.26 and 6.64 in 1998 and 2004 respectively; board of directors is 3.48 and 4.77 in 1998 and 2004 respectively;ethics and conflicts of interest is 4.16 and 4.59 in 1998 and 2004 respectively; shareholder rights is 2.75 and 4.02 in 1998 and 2004 respectively. The above result indicates that firms are performing better in terms of disclosure and firms are performing poor regarding shareholder rights. They also added that corporate governance quality varies in the firms within the same country.

2.8. Lazarides and Drimpetas (2011) Study

Lazarides and Drimpetas (2011) study examined the corporate governance quality considering the total sample of 303 observations of 60 firms of two stock indexes (FTSE-20 and FTSE-40) of the Greek capital market from 2001 to 2006. Total 12 elements are considered to assess the corporate governance quality which includes CEO duality, audit committee, compensation committee, nominee committee for board members, number of independent members, number of independent members on audit committee, committee for the evaluation and recruitment of executives, internal statute, code of ethics of for corporate governance, disclosure of board members biographical notes, disclosure of board members and executives compensation. They collected data from the annual report and developed the index of corporate governance quality considering binary variable and score 1 if the answer of the variable is true otherwise score 0 and corporate governance score ranges from 0 to 12. They stated that if the corporate governance index is low, it does not mean that the firm has low level of corporate governance and if the corporate governance index is high, it does not mean that firm is practicing best corporate governance mechanisms.

They stated that corporate governance index is influenced by time, sector and index ranking. They classified the corporate governance index into two groups and first group consider the value between 1 to 4 and second group consider the value of 6 to 8. They find that only 16.5% of the firm is ranked in the second group but 80% of the firm is ranked in first group and they find that corporate governance quality is not high in Greece. They also divided the firms into FTSE-20 index and FTSE-40 index and find that larger firms (FTSE-20) practice higher corporate governance than small firms. They also find that corporate governance index of financial firms are higher than non financial firms.

Finally, they concluded that policy makers should develop the legal regulatory framework to improve the level of corporate governance quality. 

2.9. Biswas (2012) Study

Biswas (2012) study investigated the corporate governance quality using total 2305 firm years’ observations of public listed companies of Dhaka Stock Exchange (DSE) from Bangladesh during the period of 996 to 2009. He stated that corporate governance quality is composed of total 148 elements into five poad sub categories such as ownership structure and investor rights (15 attributes), financial transparency, and information disclosure in the annual report (24 attributes), board, management structure and process (80 attributes), auditing (13 attributes), and corporate responsibility and compliance (16 attributes) considering corporate governance guidelines 2006, regulatory and legal requirement, disclosure practices of listed companies and prior empirical literature. Corporate governance quality is measured by corporate governance score and score 1 for each attributes if the firm comply the requirement of the attributes otherwise score 0 following the prior studies (Cooke, 1989, 1993; Williams, 2001; Bujaki & McConomy, 2002; Barako et al., 2006). He stated that any undisclosed attributes scored 0 which avoid the judgment error during coding process and this is considered following the study of Morris et al. (2011). He also stated that any undisclosed item means (1) the firm does not have the attributes; or (2) the firm has the attributes but it is immaterial to disclose it or (3) the firms has attributes, it is material but the firm chose not to disclose it. He used the un-weighted disclosure model and all attributes are scored equally to avoid subjectivity and this equally weighted system is consistent with Cooke (1989, 1993). After scoring of all attributes, corporate governance score is computed by adding the scores and the score ranges from 0 to 148.

The average mean of corporate governance score 35.81 and ranges from 12 to 104 with a standard deviation of 17.512. The lowest mean score is 23.68 in 2006 and the highest mean score is 62.79 in 2009 and the score is increased over the year as expected and he stated that listed companies adopted various changes in their governance after implementation of corporate governance guidelines 2006 but the governance score in different areas like board, management structure and process are low in compare to other countries. He also stated that firms have developed their governance slowly over the year. 

2.10. Gordon et al. (2012) Study

Gordon et al. (2012) study examined corporate governance quality using total 702 small publicly traded companies listed on Toronto Stock Exchange (TSE) Venture Exchange in 2004. They developed the corporate governance score considering 22 key factors of 14 TSE corporate governance guidelines and the score is computed by adding all 14 relevant TSX guidelines. They divided the corporate governance score in two categories such as board composition and policies. Board composition includes board independence, independent directors in audit committee, compensation committee, and nominating committee, CEO duality, Chairman of the board, existence of a process for performance evaluation of the board, its members and supporting committees, directors’ independence to meet with management, chairman of the board is an independent director, availability of nominating committee, compensation committee and corporate governance committee and each item is scored 1 and adding of all items compute the score of composition where as policies include strategic position, code of conduct or ethics, orientation and education program for the board, external advisors affiliation, evaluation of board effectiveness, policy of disclosure and policy is computed after deducting the composition score from corporate governance score.

The descriptive statistics presents that the average mean of corporate governance score is 3.223 and ranges from 0 to 19 with a standard deviation of 3.94. The average of board composition is 1.96 and minimum is 0 and maximum is 11 with a standard deviation of 2.08 and average mean of policies is 1.27 and ranges from 0 to 9 with a standard deviation of 2.49.

They concluded that owners and managers should focus on good governance because good governance is the main driving force of small firm.

2.11. Waweru (2014a) Study

Waweru (2014a) study examined corporate governance quality considering total 247 firm year observations of 50 largest firms listed on Johannesburg Stock Exchange (JSE) of South Africa during 2006 to 2010. Quality of corporate governance is measured by board size, proportion of non executive director and shareholder concentration. Board size is measured by the total number of directors, proportion of non executive director is computed by percentage of non executive directors on the board and shareholder concentration is measured by the percentage of shares held by 10 largest shareholders to total shares.

The descriptive statistics presents that corporate governance quality is high in South Africa which implies that firms highly comply the corporate governance requirements. The average mean of ownership concentration is 63.2% which indicates high involvement of institutional investors. The average mean of board size is 13.8 and ranges from 4 to 27 which indicate that all the sample firms followed the listing code of JSE. The proportion of non executive director is 73.8% which implies that boards are controlled by non executive director.

He stated that the findings of the study will improve quality of corporate governance and reduce the corporate failure and protect the interest of minority shareholders and thus concluded that high quality of corporate governance is the precondition of a good business.

2.12. Waweru (2014b) Study

Waweru (2014b) study examined the corporate governance quality using 247 firm year observations of 50 largest companies listed on Johannesburg Securities Exchange (JSE) of South Africa and 234 firm year observations of 49 companies listed on Nairobi Stock Exchange (NSE) from 2006 to 2010. Quality of corporate governance index is measured by corporate governance index and it is divided into six sub-categories such as board (19 attributes), charter or laws (5 attributes), audit (6 attributes), director composition (6 attributes), progressive practices (11 attributes) and ownership (4 attributes). He considered total 51 binary attributes to measure the corporate governance score. Each item is scored 1 if the attributes is present otherwise score is 0.

The descriptive statistics presents that the average mean of quality of corporate governance score is 37.48 or 73.3% and ranges from 25 to 45 with a standard deviation of 3.4051 in South Africa which indicates that firms are highly following the corporate governance requirements in South Africa. The descriptive statistics also presents that the average mean of quality of corporate governance score is 26.35 or 52% and ranges from 16 to 34 with a standard deviation of 1.96 in Kenya which indicates that corporate governance quality in Kenya is lower than South Africa.

He concluded that high operating performance influence the quality of corporate governance and high quality of corporate governance reduce information asymmetry and conflict of interest and thereby ensures larger shareholder wealth.

2.13. Tchuigoua (2015) Study

Tchuigoua (2015) study used the score of Planet rating, the specialized rating agency, to assess the quality of corporate governance. He considered total 178 micro financial institutions of 53 countries rated by Planet Rating during 2001 to 2011. Corporate governance quality is measured by the corporate governance index which considers governance, information, risk management, activity, funding and liquidity, efficiency, (in short form, GIRAFE) of micro financial institutions.

2.14. Turrent and Ariza (2016) Study

Turrent and Ariza (2016) study examined quality of corporate governance through corporate governance rating considering total 826 observations of 128 highest ranked companies on the stock exchange of Argentina, pazil, Chile and Mexico during 2004 to 2010. Corporate governance rating includes total 43 items, with a maximum value of 100, and divided into four sub categories such as composition and performance of the board, shareholder rights, ethics and conflicts of interest and other information related to corporate governance and each sub category is weighted as 53, 18, 16 and 13% respectively.

The descriptive statistics presents that the average mean of corporate governance rating is 0.36, 0.48, 0.53 and 0.66 in Argentina, pazil, Chile and Mexico respectively and the average mean of overall corporate governance rating is 0.53 and ranges from 0.12 to 0.81 with a standard deviation of 0.17 in 2004. It is also evident that the average mean of corporate governance rating is 0.64, 0.72, 0.64 and 0.78 in Argentina, pazil, Chile and Mexico respectively and the average mean of overall corporate governance rating is 0.70 and ranges from 0.37 to 0.88 with a standard deviation of 0.12 in 2010. They find that corporate governance rating is increased over the year after comparing between 2004 and 2010 because good governance and regulation have increased and changed over time. They also added that codes of good governance and different level and mechanism of corporate transparency of each country influence corporate governance rating and thus rating varies country to country.

The overall summary of the quality of corporate governance is presented in Table 1.

[Table 1] Summary Studies of Quality of Corporate Governance ​​​​​

3. Conclusion

Quality of corporate governance helps to assess whether firms are practicing better quality or worst quality in governance issues. Daily & Dalton (2004) and Khanchel (2007) study also stated that corporate governance quality distinguish the firms between best and worst. Khanchel (2007) study stated that corporate governance quality is important because investors (like institutional investors) uses the quality to perform a crucial role in the capital market and management give special emphasize on corporate governance quality when quality of corporate governance is at bottom line. This study finds that corporate governance quality is measured by different names such as corporate governance ranking, corporate governance score, corporate governance index, corporate governance quality in percentage form, corporate governance rating etc. though the basic objectives are same. Most of the researchers developed their self structured corporate governance index on the basis of code of best practice or governance guidelines, listing requirement, disclosure practices, corporate law or law applicable for companies, and previous literature to measure the corporate governance quality where as few researcher used the corporate governance index provided by rating agencies. This study observed that variation of- overall and individual attributes of corporate governance; categories or sub-indices of corporate governance; scoring in each item; weighted and unweighted method; statistical method; time period; financial and non financial companies; guidelines or requirement in the code of best practice or corporate governance; listing requirement; disclosure practices; legal environment, firms characteristics and country perspective and therefore, there is no unique measurement or process to assess the quality of corporate governance. This study also finds that quality of corporate governance varies in the firms within the same country. This study also observed that overall corporate governance quality is very low in most of the studies though the measurement of corporate governance quality is different. This study recommends that the boundary of corporate governance quality should be defined based on the agreed set of rules and regulation, code of governance and practices. This study also suggests that the regulator and policy makers should more emphasize on code of corporate governance and regulatory framework and monitoring to improve the quality of corporate governance.