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turbulence and financial performance of UAE listed firms. Mostafa Kamal Hassan. Department of Accounting, Finance and Economics, University of Sharjah,.
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Corporate governance, economic turbulence and financial performance of UAE listed firms

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Mostafa Kamal Hassan Department of Accounting, Finance and Economics, University of Sharjah, Sharjah, United Arab Emirates and Department of Accounting, Alexandria University, Alexandria, Egypt, and

Sawsan Saadi Halbouni Department of Accounting, Finance and Economics, University of Sharjah, Sharjah, United Arab Emirates Abstract Purpose – The purpose of this paper is to investigate the effect of corporate governance mechanisms on the financial performance of the United Arab Emirates (UAE) listed firms. Design/methodology/approach – Relying on a sample of 95 UAE listed firms affiliated to financial and non-financial sectors, the paper performs a cross-section regression analysis to test whether there is a significant relationship between governance mechanisms (voluntary disclosure, CEO duality, board size, board committee and audit type) and UAE firms’ performance while controlling for firm size, industry type, firm listing years and leverage. The paper relies on data published on year 2008 and utilizes the accounting-based measures of Return on Assets (ROA), Return on Equity (ROE) as well as the market measure (Tobin’s Q) in order to measure the UAE firms’ financial performance. Findings – The empirical results show that voluntary disclosure, CEO duality and board size are significantly influencing the UAE accounting-based performance measure, while none of the governance variables significantly affects firms’ market performance measure. The results also reveal that firm size is the only control variable that significantly influences firms’ performance. This paper provides evidence showing that the accounting-based performance measures are more objective in the years where unstable economic conditions exist. Practical implications – The paper’s findings indicate that the underlying principles of corporate governance are applicable in emerging markets. The findings are important to regulators, investors, managers, and researchers aiming at developing new policies that establish better regulatory infrastructure that increases investors’ confidence and attracting foreign investment. Originality/value – The paper is one of very few studies that examine the relationship between corporate governance and firms’ financial performance under economic turbulent in an emerging market economy, the UAE. Keywords United Arab Emirates, Corporate governance, Financial performance, Agency theory, Performance measures, Accounting performance measures, Market performance measures, Emerging economy Paper type Research paper

Studies in Economics and Finance Vol. 30 No. 2, 2013 pp. 118-138 q Emerald Group Publishing Limited 1086-7376 DOI 10.1108/10867371311325435

1. Introduction The literature on the relationship between governance mechanisms and firms’ performance has occupied a considerable attention (Weir et al., 2002; Aljifri and Moustafa, 2007; Kholeif, 2008; Mashayekhi and Bazaz, 2008; Stanwick and Stanwick, 2010;

Ghazali, 2010). The underlying motive behind that literature lies on managers-shareholders’ “conflict of interest” inherited in principal-agent relationship (Jensen and Meckling, 1976). That conflict increase organizational agency costs due to the lack of controlling devises on the hand of shareholders (Fama and Jensen, 1983). At the heart of these organizational problems, corporate governance mechanisms have been utilized to align principal-agent interests and consequently improve organizational performance (Bhagat and Bolton, 2008; McKnight and Weir, 2009). Moreover, the empirical studies examining the relationship between corporate governance and firms’ performance have generated inconclusive results (Gani and Jermias, 2006; Larcker et al., 2007; Mashayekhi and Bazaz, 2008; Stanwick and Stanwick, 2010; Bauer et al., 2008; Ghazali, 2010). Some studies provide evidence that shows a positive effect of corporate governance on firms’ performance (Hossain et al., 2000; Lee et al., 1992). Other studies report a negative association between corporate governance and firms’ performance (Hutchinson, 2002), while other studies find no impact of corporate governance on firms’ performance (Ponnu, 2008; Gupta et al., 2009). There are several possible explanations for governance-performance relationship inconclusive results. First, the institutional differences across countries in which these studies were carried out. Some of these studies are conducted in European and Western context (Hossain et al., 2000; Weir et al., 2002; Hutchinson, 2002; Hutchinson and Gul, 2004; Gupta et al., 2009; Stanwick and Stanwick, 2010). Other studies are conducted in Asian countries such as Malaysia (Ponnu, 2008; Haat et al., 2008; Ghazali, 2010) and China (Sami et al., 2011) as well as in Middle Eastern countries such as Egypt (Kholeif, 2008) and Iran (Mashayekhi and Bazaz, 2008). The intra-countries institutional differences partially explains the governance-performance relationship inconclusive results and, at the same time, raises concern about whether the principles of corporate governance which originated from developed countries are applicable in other countries. Second, the choice of performance variables might also play a role in explaining the governance-performance relationship mixed results. Some studies utilize accounting-based performance measures such as return on assets (ROA), return on equity (ROE), asset turnover, or earning per share (Hutchinson and Gul, 2004; Gani and Jermias, 2006; Kholeif, 2008; Mashayekhi and Bazaz, 2008) while others use market-based performance measures such Tobin’s Q (Yermack, 1996; Weir et al., 2002; Aljifri and Moustafa, 2007; Haat et al., 2008; Ghazali, 2010). This paper investigates the effect of corporate governance mechanisms on the United Arab Emirates (UAE) listed firms’ performance. There are several reasons to choose the UAE for this study. First, there is paucity of studies that investigate governance-performance relationship in the UAE except for Aljifri and Moustafa (2007) study which relies on Tobin’s Q as a measurement of firms’ performance. Gani and Jermias (2006) argue that market-based measures, such as Tobin’s Q, tend to be more objective than accounting-based measures, yet they are also affected by many uncontrollable factors. Likewise, Hutchinson and Gul (2004) argue that accounting-based performance measures are preferable when investigating the relationship between corporate governance and firms’ performance. One of the paper contributions is that it relies on the accounting-based and market-based measures to examine the governance-performance relationship for UAE listed firms. Second, the UAE introduced a code of corporate governance by mid of 2007. Since the paper relies on information published by end of 2008, the paper, therefore,

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examines the impact of the code requirements on the UAE listed firms’ performance after the introduction of its code of governance. Third, the paper uses data set from year 2008, the year of the global financial crisis. That year represents an attractive opportunity to examine governance-performance relationship since prior studies tend to overlook the effect of economic instability on such a relationship (Aljifri and Moustafa, 2007; Ghazali, 2010; Sami et al., 2011). The paper, therefore, provides additional insights on the objectivity of different performance measures, i.e. market and accounting measures, under turbulent economic conditions resulted from the financial crisis. The remainder of the paper is organized as follows: Section 2 discusses the paper literature review that explains the linkages between agency theory, governance mechanisms and firms’ performance. Section 3 includes hypothesises development, while Section 4 describes the methodology. Section 5 presents results and discussion. Finally, Section 6 includes conclusion, limitations and future research. 2. Literature review 2.1 Agency theory and firms’ performance Agency theory provides a framework that links corporate governance with firms’ performance ( Jensen and Meckling, 1976). Within agency theory framework, companies are defined as nexus of contracts under which one party (the principal) engages with another party (the agent) to perform some service on their behalf (Subramaniam et al., 2009). On the one hand, the agent is generally assumed to act based on his/her self-interest ( Jensen and Meckling, 1976). On the other hand, the principal monitors agent’s behavior through adopting governance mechanisms. Since corporate governance mechanisms provide additional checks on managerial behavior, governance mechanisms not only reduce the possibility that top managers will enhance their interests by using information asymmetries but also force managers to behave in such a way that maximize shareholders’ value (Eng and Mak, 2003; Gul and Leung, 2004; Chen and Jaggi, 2000). Jensen and Meckling (1976) argue that the divergence of interest between the principals (shareholders) and the agents (managers) leads to agency costs. Henry (2007) adds that effective monitoring devices, such as governance mechanisms, facilitate the alignment of interests between shareholders and managers. That alignment reduces the firm’s agency costs and consequently improves the firm’s performance. Agency theory underlying assumption is that managers (agents) may engage in self-interest decision and therefore shareholders (principals) enforce governance mechanisms to monitor agents’ decision-making processes and consequently improve their firms’ performance. 2.2 Governance mechanisms and firms’ performance Larcker et al. (2007) argue that corporate governance refers to a set of mechanisms that influence the decisions made by managers when there is a separation of ownership and control. Corporate governance is defined as a mix of different mechanisms that direct and control the organization (Ryan and Ng, 2000, p. 13; Solomon and Solomon, 2004; Kim et al., 2005; Hassan, 2008). Ryan and Ng (2000, p. 13) highlight two aspects of corporate governance: conformance and performance. Conformance, they argue, includes elements of monitoring, supervising and being accountable to different stakeholders.

Performance, they add, describes the contribution of those who govern the organization to its performance. Governance, in short, is not only concerned with the processes of decision making but also with the controls that support effective accountability for performance outcomes (Weir et al., 2002). Although corporate governance is a set of mechanisms that direct and control firms in order to maximize value to stakeholders, Hassan (2008) argues that governance per se is looked at from two perspectives: a more macro perspective and a micro perspective. This micro/macro distinction coincides with the classification of governance mechanisms into two categories: internal and external mechanisms (Weimer and Pape, 1999; Hassan, 2011). Articulating this distinction to agency theory, corporate governance – at micro organizational level – includes internal mechanisms that align interests of firms’ managers with firms’ objectives as well as with the interests of shareholders while, at the same time, monitoring the performance of these managers (Solomon and Solomon, 2004, p. 8; Kim et al., 2005). At a more macro level, governance is seen as “a set of institutional and market mechanisms”, external to the firm, that exert pressures on firms’ managers to make decisions that maximize the value to their firms’ stakeholders (Lapsley, 1993; Hassan, 2008). Likewise, Weir et al. (2002) argue that internal mechanisms include compensation contracts, bonding activities and monitoring activities within the firm, while external mechanisms include monitoring activities by the capital market, legislators, professionals and investors. Despite these differences, both types share a common objective that seeks to align managerial interests with the interest of shareholders. In a similar vein, Weimer and Pape (1999) explain the difference between governance “systems” and “mechanisms”. Governance systems, they define, are the intra-country institutional, legal and professional frameworks that legitimate stakeholders’ right to receive a feedback they expect and, at the same time, hold organizations managers’ accountable. The corporate governance mechanisms, they add, are the methods employed, at the organizational level, to resolve agency problems. Weimer and Pape (1999) argue that governance “systems” and “mechanisms” are interrelated since the latter rest on the former. The above studies suggest that “performance”, “decision making” and “mitigating the conflict of interests”, are integral parts of corporate governance mechanisms. Some scholars posit that governance mechanisms reduce agency costs and consequently enhance the firm’s return on investment (Conyon and Peck, 1998; Hossain et al., 2000). Other scholars argue that good corporate governance mechanisms improve the firm’s performance (Chung et al., 2003; Fernandes, 2008; Bhagat and Bolton, 2008). Their underlying assumption is that better governance leads to a reduction of the firm’s cost of capital, a better set of investments, a better allocation of resources, a higher growth and a better relationship with shareholders. In short, they argue that better governance mechanisms mitigate the conflict of interest between firms’ managers and firms’ shareholders. Haniffa and Cooke (2002) add that corporate governance mechanisms may have an influence on firms’ performance. The adoption of internal control devices, such as board size, number of committees supporting the board of directors and separation of the roles of chairman and chief executive, may enhance monitoring quality and consequently improve firm’s performance (Larcker et al., 2007; Mashayekhi and Bazaz, 2008; Stanwick and Stanwick, 2010; Ghazali, 2010). The existence of these internal

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governance mechanisms may reduce the scope for managerial opportunism and consequently firm performance should be improved. Although the influence of corporate governance mechanisms on firms’ performance has been investigated in developed countries (Hossain et al., 2000; Weir et al., 2002; Hutchinson, 2002; Hutchinson and Gul, 2004; Gupta et al., 2009; Stanwick and Stanwick, 2010), few studies examine that influence on Middle East region (Moustafa, 2005; Aljifri and Moustafa, 2007; Kholeif, 2008; Mashayekhi and Bazaz, 2008). For example, Moustafa (2005) examines the effect of separation between ownership and control on UAE firms’ performance. Relying on a longitudinal set of data covering the period between 1998 and 2002, he found that owner-controlled firms significantly outperform the management-controlled ones in the UAE. Mashayekhi and Bazaz (2008) investigate the effect of internal governance mechanisms on Iranian listed firms’ performance. They examine the effect of board size, board independence, board leadership and institutional investors on earning per share, ROA and ROE. Mashayekhi and Bazaz (2008) found that board independence has a positive impact on firm performance, while board size has a negative impact. At the same time, they found that board leadership and institutional investors do not show any significant effect on Iranian firms’ performance. Kholeif (2008) re-examines the negative association between CEO duality, as internal governance mechanisms and corporate performance. His study found that CEO duality is negatively affects Egyptian listed forms’ performance if these firms have large board of directors and lower top management ownership. Aljifri and Moustafa (2007) examine the relationship between internal and external governance mechanisms and UAE listed firms’ performance. They regress institutional ownership, governmental ownership, board size and auditor type on firms’ performance measured by Tobin’s Q. Relying on year 2004 data; they found that governmental ownership is significantly affects firms’ performance whereas board size, institutional investors and firm size show in-significant impact on firms’ performance. Although this paper shares similarities with the previously mentioned studies, it differs from them in two major aspects: first, this paper investigates governance-performance relationship under economic turbulent conditions. Second, the paper utilizes two sets of performance measures, market-based measures and accounting-based measures, in order to test governance-performance relationship which, in turn, examines the objectivity of each set of measures under economic crisis conditions. 3. Hypotheses development 3.1 Disclosure and firms’ performance Firms’ managers are inclined to provide voluntary disclosures on the best practice of governance adopted by their firms (Hassan, 2009, 2011, 2012). This disclosure, Healy and Palepu (2001) argue, makes financial statements users aware of their managerial ability and avoid misevaluation of their actions and performance. Reducing information asymmetry could be another benefit behind voluntary disclosure on corporate governance practices (Bushman and Smith, 2001; Hassan, 2011). On the one hand, the provision of voluntary information will improve managers’ corporate picture. It also helps corporations to avoid litigation costs (Bushman and Smith, 2001). On the other hand, voluntary disclosure of governance practices will provide information to stakeholders about how the concerned corporation is managed.

Bushman and Smith (2001) argue that the board’s disclosures are one of the essential mechanisms that enhance the firm’s performance. Healy and Palepu (2001) add that level of disclosures by the board of directors can have a significant impact on the firm’s performance. These scholars argue that voluntary disclosure enable stakeholders to have a clearer understanding of how decisions are made within the firm. Therefore, the paper hypothesizes that: H1. The higher the level of voluntary disclosures of governance practices the better the firm’s performance. 3.2 Board size The board of directors is an important internal governance mechanism that enables in reducing agency problems inherent in managing any organization (Cerbioni and Parbonetti, 2007; Haat et al., 2008; Khanchel, 2007; Li et al., 2008). Based on agency theory, several scholars articulate board size to firms’ performance in two opposite ways. On the one hand, some scholars argue that the coordination/communication problems among the board’s members increase as the board size increases (Cerbioni and Parbonetti, 2007; Bushman et al., 2004). Lipton and Lorsch (1992) argue that as the board size increases, it becomes more difficult for the company to arrange board meetings as well as reach board members’ consensus regarding issues discussed in these meetings. The consequence of these problems is that larger boards need longer time to take decisions and consequently these boards are less efficient in capturing business opportunities (Bantel and Jackson, 1989). In contrast, other scholars suggest that small boards augment the company monitoring capabilities (Khanchel, 2007; Yermack, 1996). They argue that the monitoring capability of the board decreases with its size. Since there is no predominant theory suggesting a specific association between the board size and the firm performance, the paper proposes a non-directional hypothesizes as follows: H2. There is an association between board size and firm performance. 3.3 Role duality “Role duality” is another aspect of the internal governance mechanisms (Haat et al., 2008). Role duality means that the same person undertakes the role of chief executive officer and the role of chairman board of directors (Forker, 1992). Based on agency theory, scholars argue that the separation of the two roles improves the board’s monitoring capabilities (Cerbioni and Parbonetti, 2007; Haat et al., 2008; Li et al., 2008). Khanchel (2007) argues that the role duality diminishes the board independence, reduces the flexibility of the board of directors and consequently reduces the possibility that the board can properly execute its oversight role. Therefore, the paper hypothesizes that: H3. There is a negative relationship between CEO duality and firm performance. 3.4 Board committees One of corporate governance mechanisms is the board committees (i.e. the compensation, risk management, audit, governance and nominating committees). John and Senbet (1998) findings suggest that the presence of monitoring committees is positively related to factors associated with the benefits of monitoring. Khanchel (2007) adds that corporate governance quality increases with the existence of separate committees and also with their meetings. Li et al. (2008) post that board monitoring

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capability is a function of the board’s committees where much of the important processes and decisions are monitored and taken. In this regard, Klein’s (2002) study findings show that the existence of independent board’s committees reduce the likelihood of earnings management, thus improving performance. Therefore, board committees can be expected to improve internal control and consequently improve corporate performance. Accordingly, the paper hypothesizes that: H4. There is a positive relationship between board committees and firm performance. 3.5 Audit type Becker et al. (1998) indicate that the high-quality auditors are the more likely to detect questionable accounting practices and qualify the audit report. Davidson and Neu (1993) argue that audit quality is the main factors that determine the credibility of firms’ financial information and consequently its financial performance. Aljifri and Moustafa (2007) add that big audit firms have bigger chance to control opportunistic management behaviors and therefore improving the firm performance. Likewise, Haat et al. (2008) argue that firms which are audited by one of Big Four audit firms, as a proxy for audit quality, will have a better performance. Bulut et al. (2009) add that high reputable audit firms deeply examine the financial information, therefore, firms which employ reputable auditing firm present better investment performance. Davidson and Neu (1993) argue that firms engaged with higher quality audit firms are less fortunate to manipulate income figures than those firms engaged with lower quality audit firms. Therefore, the paper hypothesizes that: H5. There is a positive association between audit type and firm performance. 4. Methodology 4.1 Sample The data for this study were collected from the 2008 firms’ annual reports. The annual reports were downloaded from the Emirates Security and Commodity Market Authority (ES&CMA). The year 2008 was chosen to see whether the introduction of the UAE code of governance in 2007 have an impact on firms’ performance. The sample includes 95 corporations distributed across different sectors as follows: banks (n ¼ 20), insurance (n ¼ 25), finance/investment (n ¼ 8), manufacturing (n ¼ 24) and other non-financial service corporations such as properties development and management (n ¼ 18). The population of 95 corporations is divided into two sub-samples: the first includes 53 corporations in banking, financing, investing and insurance corporations (i.e. financial sector) and, the second incorporates 42 industrial and non-financial service corporations (i.e. non-financial sector). 4.2 Research design and variables measurements The paper applies a cross-sectional regression analysis to test whether there is a significant relationship between corporate governance mechanisms (i.e. disclosure, CEO duality, board size, board committees and audit type) and firms’ performance. The paper regress firms performance, as a dependent variable, to corporate governance variables and control variables. The following subsections discuss how the paper’s variables are measured.

4.2.1 The dependent variable: firms’ performance. In the context of this paper, firms’ performance is measured using two sets of variables: accounting-based and market based measures (Sami et al., 2011; Kyereboah-Coleman, 2007). Accounting-based variables include ROE measured as the net income divided by total equity, and ROA measured as the net income divided by total assets (Hutchinson and Gul, 2004; Gani and Jermias, 2006; Kholeif, 2008; Mashayekhi and Bazaz, 2008). The paper also uses Tobin’s Q as a market-based measure of performance (Yermack, 1996; Weir et al., 2002; Aljifri and Moustafa, 2007; Haat et al., 2008; Ghazali, 2010). Tobin’s Q provides an estimate of the intangible assets value such as the market power, goodwill, quality of the management and growth opportunities (Weir et al., 2002; Hutchinson and Gul, 2004, p. 605; Gani and Jermias, 2006; Aljifri and Moustafa, 2007; Ghazali, 2010). Tobin’s Q is measured as the market-to-book value (MVBV) ratio. MVBV ratio is the year end market value of the firm divided by book value of total assets at end of 2008. The use of these two sets of firms’ performance lies on the agency theory underlying assumption that agents, i.e. corporate managers, exhibit a preference for accounting-based performance since these measures are easier to control than external or market-based measures (Hutchinson and Gul, 2004, p. 605; Gani and Jermias, 2006). Therefore, the use of market-based measures of firms’ performance is more objective since it less controllable by corporate managers. Market-based measures, however, are more subject to exogenous uncontrollable economic factors (Hutchinson and Gul, 2004, p. 605; Gani and Jermias, 2006). Accordingly the paper utilizes both accounting and market-based performance measures, since it seems reasonable to cross-check the effect of different governance mechanisms on firms’ performance. 4.2.2 The statistical model and independent variables. The relationship between independent variables, i.e. corporate governance mechanisms, and firms’ performance is tested through the model presented below: FirmPerformance ¼ b0 þ b1 GovDisclosure þ b2 CEODuality þ b3 BoardSize þ b4 BoardCommittees þ b5 Audittype þ b6 FirmSize þ b7 Industry þ b8 Listing þ b9 Leverage The paper relies on prior studies on corporate governance and firms’ performance to measures both the corporate governance and the control variables (Haniffa and Cooke, 2002; Haat et al., 2008; Cerbioni and Parbonetti, 2007; Li et al., 2008; Ajifri and Moustafa, 2007; Khanchel, 2007; Khiari et al., 2007; Hutchinson and Gul, 2004; Gani and Jermias, 2006; Kholeif, 2008; Mashayekhi and Bazaz, 2008; Ghazali, 2010; Hassan, 2011, 2012). One of the underlying reasons to choose these independent variables is the availability of data. The paper obtained data related to these variables from the UAE firms’ annual reports published by end of 2008. Annual reports incorporated information about board size, number of committees, whether the chairman of the board is also the CEO (i.e. duality) and other controlling variables. Nonetheless, the paper relies on Hassan’s (2011, 2012) extensive review of prior studies to develop a corporate governance disclosure index reported in the UAE firms’ annual reports by end of 2008. Hassan (2012) crafted a weighted index where mandatory items had less weight. For the purpose of this paper voluntary disclosure of governance practices (Gov Disclosure) is defined as the release of voluntary information related to governance dimensions such as management processes, investors’ rights, ownership structure and any other information that discharges corporate management responsibilities

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(Hassan, 2011, 2012). To measure corporate governance voluntary disclosure (Gov Disclosure), the paper modified Hassan (2012) index. Hassan (2012) index items were checked against the UAE regulatory requirements, such as UAE code of governance, Corporation ACT of 1984 and ES&CMA listing conditions, to remove items mandatory required by the UAE regulatory institutions. This checking process develops an index of 24 items. These voluntary items represent the UAE firms’ voluntary disclosure of information outside the UAE regulatory requirements. The UAE listed firms’ annual reports are then examined against the index of 24 items. This examination process leads to: first, the elimination of items that are not reported in the annual reports or reported by fewer than four firms, second, the modification of some items in the light of information published in the UAE firms’ annual reports and, finally, the addition of items practiced, i.e. applied, by the UAE firms but not included in the index. Accordingly, the final crafted index, after checking against annual reports, incorporates 29 items. One of the important aspects during crafting a disclosure index is whether some items should be weighted more heavily than others. For the purpose of this study the index items are not weighted because the study does not focus on the preferences of a particular user group. The index is crafted solely for the purpose of measuring the variation in governance practices across the UAE firms and testing the governance-performance relationships. Furthermore, several studies found that the use of weighted or un-weighted disclosure index leads to similar results (Al-Razeen and Karbhari, 2004; Hassan, 2009). Therefore, the contents of each annual report were compared to the final index of 29 items. The item is assigned a value of 1 if disclosed or 0 if not disclosed. The governance disclosure index of 29 items is assessed for internal consistency with Cronbach’s coefficient a. Cronbach’s coefficient a assesses the degree to which correlation among the index items is diminishing due to random error. Cronbach’s coefficient a for governance disclosure index is 0.704. Prior studies consider 0.70 as an acceptable level of Cronbach’s a for assessing scale reliability (Barako et al., 2006). This confirms that the index is a reliable proxy for firms’ voluntary disclosure of governance practices. As for other governance variables, the paper follows pervious studies to measure these variables. Accordingly, the paper measures: the role duality (CEO Duality) by a dummy variable that takes the value of 1 if the CEO is also the chairperson of the board and 0 otherwise, the board of directors size Board Size) by the total number of directors, the board committees (Board Committees) by total number of board committees mentioned in the annual reports; the auditor type (Audit Type) using dummy variable that takes the value of 1 if the external auditor is one of the Big Four audit firms and 0 otherwise. The paper controls for the firm size measured by the logarithm of the total assets. Ghazali (2010) argues that the bigger the firm is the more likely that it is profitable due to economies of scale, the ability to obtain cheaper sources of funds and the greater diversification. The paper also controls for industry type. The paper expects that the monitoring role of the central bank will affect the quality of corporate governance for firms working in the financial sector and consequently the performance of those companies will be better than firms belonging to other sectors. Industry type is measured by a dummy variable that takes a value of 1 if the firm belongs to the

financial sector or 0 otherwise. Listing years, measured by the number of years in which the firm is listed in the capital market and finally, firm leverage measured by total debt to total assets. The paper expects that the amount of leverage in a firm’s capital structure impacts the agency conflict between managers and shareholders through constraining managers and encouraging them to act more in the interest of shareholders. This may positively affect firm’s performance (Ebaid, 2009).

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127 5. Results and discussion 5.1 Descriptive statistics Table I presents descriptive statistics of the model variables[1]. The model variables have considerable dispersion in the scores, as represented by the minimum, maximum and the standard deviation. Table I shows that the range of the MVBV is 4.54 with a minimum of 0.00 and maximum of 4.54 and a standard deviation of 9.4. It also shows that the range for voluntary disclosure is 20 with a mean of 16.63 and the highest standard deviation of 3.68. The table also shows that the board committee has a mean of 1.31 and a standard deviation of 2.06. Furthermore, it indicates that the average number of board size lies between 3 and 15 with a mean of 7.42 and a standard deviation of 2.05. The model incorporates two sets of explanatory independent variables (governance variables and control variables), therefore, it is of importance to check the existence of multicollinearity (Hassan, 2009). Multicollinearity is a situation where two or more of the independent variables are highly correlated, therefore, it has damaging effects on the regression analysis results. The paper tests multicollinearity through the correlation matrix (Cerbioni and Parbonetti, 2007; Weir et al., 2002; Aljifri and Moustafa, 2007; Kholeif, 2008; Mashayekhi and Bazaz, 2008; Stanwick and Stanwick, 2010; Ghazali, 2010; Hassan, 2009). Although, there is no agreement among researchers regarding the cut-off correlation percentage, Field (2000) suggests that correlation greater than 70 per cent may create the multicollinearity problem. Table II shows that multicollinearity problem does not exist among the model explanatory variables. The only significant relationship exists between ROE and ROA, yet this would not cause a problem since each dependent variable will be regressed to independent variables in a separate regression model.

ROE ROA MVBV Gov Disclosure CEO Duality Board Size Board Committees Audit Type Firm Size Industry Listing Years Leverage

n

Range

Minimum

Maximum

Mean

SD

95 95 92 95 95 93 95 94 95 95 93 95

7.76 4.50 4.54 20 1 12 8 1 12.12 1 8.75 9.13

2 7.34 2 3.81 0.000 7 0 3 0 0 14.24 0 0.25 0.001

0.41 0.69 4.54 27 1 15 8 1 26.37 1 9.00 9.13

0.033 0.016 1.22 16.63 0.18 7.42 1.31 0.80 21.52 0.56 4.87 0.59

0.78 0.41 0.94 3.68 0.39 2.050 2.06 0.40 2.31 0.50 2.06 0.93

Table I. Descriptive statistics of all variables

Table II. Pearson correlations among the model explanatory variables 0.493 * * 0.331 * * 0.434 * * 0.206 * 0.365 * * 0.450 * *

1 20.141 0.169

Gov Disclosure

20.123 20.039 20.200 20.082 20.034 20.112

1 20.029

CEO Duality

Note: Correlation is significant at: *0.05 and * *0.01 levels (two-tailed)

20.111 0.004 20.025 20.112 0.245 * 20.169 20.144 0.088 20.142 20.117 0.037 0.036

20.065 20.003 0.314 * * 20.090 20.124 0.033

1

20.139 20.082 20.202 * 0.077 20.139 20.099

1 0.066

MVBV

20.114 20.204 * 20.120

1 0.977 * * 0.087

ROA

0.135 0.245 * 0.326 * * 20.030 0.182 0.194

1

Boar Size

1 0.233 * 0.467 * * 0.464 * * 0.135 0.385 * *

Board Committees

1 0.410 * * 0.198 0.029 0.131

Audit Type

1 0.105 0.107 0.229 *

Firm Size

1 0.093 0.204 *

Industry

1 0.259 *

Listing Years

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ROE ROA MVBV Gov Disclosure CEO Duality Board Size Board Committees Audit Type Firm Size Industry Listing years Leverage

ROE

1

Leverage

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5.2 Multiple regression results The multiple regression results are presented in Tables III and IV. Table III shows that Gov Disclosure, CEO Duality, Board Size, Board Committee, Audit Type, Firm Size, Industry, Listing Year and Leverage explain only 23 per cent of the variance in the ROE (F ¼ 3.959, Sig. ¼ 0.000) and 21.1 per cent in the variance of ROA (F ¼ 3.645, Sig. ¼ 0.001). The table also indicates that there is no significant relationship between governance variables and market-based performance measured by MVBV (F ¼ 0.751, Sig. ¼ 0.661). The multiple regression results indicate that governance mechanisms provide insignificant weak explanation to the changes in firms’ performance measured by Tobin’s Q. This result contradicts with Aljifri and Moustafa (2007). The results also contradict with Kyereboah-Coleman (2007, p. 14) who found a significant influence of governance mechanisms on both the ROA and the Tobin’s Q. One of the underlying explanations behind this result is that the paper relies on data set obtained by end of 2008 – the year of financial crises. This year witnessed economic downturn that affected the UAE firms’ performance measured by Tobin’s Q. Table III also shows Durbin-Watson statistic for each regression model. This statistic is used to test the non-existence of autocorrelation (i.e. the assumption of independent errors). Field (2000) suggests that values less than 1 or greater than 3 should pose a problem. He adds that the closer to 2 the value is the better the model. Therefore, Durbin-Watson values, shown in Table III, are acceptable and consequently the problem of autocorrelation is not significant in this study. Since each regression model utilizes a set of explanatory independent variables, the variance inflation factor (VIF) is checked to ensure the non-existence of multicollinearity problem (Field, 2000; Hassan, 2009). The VIF calculations, shown in Table IV, indicate the non-existence of multicollinearity problem among the explanatory variables. Although there is no hard rule about what VIF value at which to multicollinearity causes a problem, scholars suggest the VIF of 10 is a good value at which to worry (Field, 2000; Hassan, 2009). The VIFs should not exceed the critical value of 10 (Field, 2000). The VIF results, therefore, support the lack of presence of multicollinearity in the regression models. Therefore, the regression analysis results can be interpreted with a greater degree of confidence. Table IV results coincide with Hutchinson and Gul (2004) and Gani and Jermias (2006) view that accounting-based performance measures are better reflection to managerial actions since they are under the management control. The table also confirms the view that market-based measures are more subject to uncontrollable economic factors. Since the paper relies on a set of data published by end of 2008, a year in which the global economic crisis took place, the market-based performance measure may not be a good reflection to the UAE firms’ performance in year 2008. Dependent variable ROE ROA MVBV

R 0.555 0.539 0.284

R2 0.308 0.291 0.081

Adjusted R 2 0.230 0.211 0.081

F 3.959 3.645 0.751

Sig.

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Durbin-Watson a

0.000 0.001a 0.661

2.192 2.200 2.117

Notes: Significant at: *0.99 level; dependent variable: accounting-based (ROE and ROA) and market based (MVBV); apredictors: (constant), Gov Disclosure, CEO Duality, Board Size, Board Committee, Audit Type, Firm Size, Industry, Listing Year and Leverage

Table III. Regression model summary

Table IV. Regression models coefficients 2 2.628 2 2.019 2 1.693 2 2.537 2 1.575 2 0.297 4.745 2 0.514 2 0.596 1.529

ROE 0.010 0.047 * * 0.094 * 0.013 * * 0.119 0.767 0.000 * * 0.609 0.553 0.130

Sig. 1.800 1.065 1.242 1.912 1.344 1.657 1.409 1.225 1.365

VIF 2 0.839 2 0.028 2 0.197 2 0.055 2 0.041 2 0.015 0.088 2 0.095 2 0.016 0.088

b

Note: The variable is important at significant level of *0.90 and * *0.95

22.220 20.055 20.339 20.102 20.078 20.065 0.196 20.091 20.024 0.140

t

ROA 21.878 21.928 21.859 22.564 21.569 20.128 4.036 21.009 20.758 1.812

t 0.064 0.057 * 0.067 * 0.012 * * 0.121 0.899 0.000 * * 0.316 0.451 0.074

Sig.

1.800 1.065 1.242 1.912 1.344 1.657 1.409 1.225 1.365

VIF

2.919 2 0.011 0.226 2 0.002 0.029 2 0.284 2 0.063 0.239 2 0.042 0.079

b

2.477 20.299 0.836 20.043 0.419 20.957 21.118 0.979 20.772 0.641

0.015 0.766 0.406 0.966 0.676 0.341 0.267 0.331 0.443 0.524

MVBA t Sig.

130

(Constant) Gov Disclosure CEO Duality Board Size Board Committees Audit Type Firm Size Industry Listing Years Leverage

b

1.802 1.060 1.238 1.997 1.334 1.648 1.407 1.218 1.371

VIF

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Table IV shows a significant inverse relationship between firms’ voluntary disclosures of governance practices and accounting-based performance measures ROE (at level of 0.99 and ROA (at level of 0.95). These results lead to the rejection of H1. The results coincides with Bujaki and McConomy (2002) findings while contradict with other studies (Bauer et al., 2008; Stanwick and Stanwick, 2010). The results of this study agree with Holder-Webb (2003) argument that managers of firms facing financial difficulties, such as the economic crisis, may choose to increase voluntary disclosure in order to mitigate uncertainties that such firms face. The result of disclosure-performance relationship does not coincide with agency theory or, what Ibrhaim et al. (2011) call, economic-based voluntary theory prediction. Yet the result agrees with the legitimacy theory predication in which poorly performed firms face more political and social pressures and therefore their legitimacy is threatened. Consequently, these firms voluntarily disclose more information in order to alter the society’s stakeholder perceptions about their actual performance. Likewise, Table IV presents a significant inverse relationship between board size and accounting-based performance measures at level of 0.95. The paper did not specify a direction of the relationship between board size and firms’ performance, and therefore the reported results indicate that there is a negative relationship implying that firms’ performance, measured by accounting-based measures, decline with the increase of the board size. The result agrees with Yermack (1996), Eisenberg et al. (1998), Fuerst and Kang (2000), Bhagat and Black (2002), Kyereboah-Coleman (2007), Mashayekhi and Bazaz (2008) and El Mir and Seboui (2008). The findings also agree with Mishra et al. (2001) argument that smaller boards help to make decision more quickly and play a controlling function where as large boards lack genuine interaction and less likely to become involved in strategic decision making (Judge and Zeithaml, 1992); Lipton and Lorsch, 1992). However, the result does not agree with that obtained by Aljifri and Moustafa (2007). The difference in the result could be attributed to the differences in the sample size, period covered, or to the difference in the performance measure used. Table IV results accept the hypothesized negative relationship between CEO duality and accounting-based measures at level of 0.90. This result coincides with Chang and Leng (2004), Rechner and Dalton (1991), Kyereboah-Coleman (2007) results, yet it contradicts with Boyd (1995) who concludes that the duality role of a CEO can have a positive effect on firms’ performance. Furthermore, Table IV rejects H4 which posts a positive relationship between board committees and firms’ performance. The regression model indicates that number of board committees has no significant effect on firms’ performance. This raises not only concern about the effectiveness of these committees, bust cast doubt on the formation and structure of these committees. The result coincides with Jackling and Johl (2009) and Hayes et al. (2004) studies that found no association between board activities, measured in terms of frequently of board meetings and firms’ performance. One of the possible explanations behind the result of committees-performance relationship is that the UAE still in its infancy stage of implementing its code of governance whereby UAE firms form different committees to monitor firms’ operations. Therefore, the duties and the structure (e.g. executive-non executive) of these committees are not well developed yet. Furthermore, committees’ members may also lack the experience because of the early of development stages of these committees in UAE listed firms (Raheja, 2005; McKnight and Weir, 2009).

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Table IV shows no significant association between auditor type and firms’ performance and therefore the paper rejects H5. This result contradicts with El Mir and Seboui (2008) that found a significant positive relationship between firms’ performance and auditor’s quality, while they coincides with Aljifri and Moustafa (2007). One possible explanation behind this result is that external auditors do not have an influence on their clients’ operational decisions. Table IV shows that firm size is the only control variable that is found to have a significant positive relationship with firms’ performance. The result posits that the bigger the firm is the better the firm performance since the firm may benefit from economies of scale. This result contradicts with Aljifri and Moustafa (2007), Ghazali (2010) and coincides with Kyereboah-Coleman (2007). The size-performance relationship can be explained in the light of the political cost theory (Watts and Zimmerman, 1986). The theory argues that the bigger the firm the more political pressure the firm faces and therefore bigger firms tend to report higher performance, that coincide with their size, to avoid political intervention through new governmental regulations. Table IV results reject other controlling variables (industry, listing years and leverage) as determinants of firms’ performance. Although central banks mostly pressurize financial institutions to adopt stronger governance mechanisms which, in turn, may improve firms’ performance, the empirical results indicate that industry has no significant relationship with firms’ performance. The industry-performance relationship result can be attributed to mimic effect wherein some firms desire to mirror other firms’ governance practices that are recognized as worthy of adopting. DiMaggio and Powell (1983, p. 151) argue that in situations where there are uncertainties (like economic turbulent during 2008) about the proper approach to proceed, it is recommended to seek a successful reference group and “mimic” their course. Therefore, one of the possible explanations of industry-performance insignificant relationship is that firms, from heterogeneous sectors (i.e. financial/non-financial), mimic each other. For example, the UAE non-financial sector voluntary adopted international accounting standards in harmony with the country financial sector that was enforced to adopt these standards by the UAE central bank (Halbouni, 2009). Furthermore, the empirical results indicate that listing years has no significant relationship with firms’ performance. These results can be attributed to the short history for UAE stock markets. Table I reveals that the maximum listing period is nine years, while the minimum is less than one year. The leverage-performance relationship result indicates that there is no significant relationship with firms’ performance. The results agree with Ebaid (2009) study that found capital structure choice has a week-to-no impact on firm’s performance and contradicts with Kyereboah-Coleman (2007) and Jackling and Johl (2009) studies that found a negative significant relationship between leverage and firms’ performance. Again, the economic turbulent took place during 2008, the sample year, maybe the cause of such a result. 6. Conclusion The regression results show that governance mechanisms explain 30.8 per cent of the change in ROE and 29.1 per cent of the change in ROA, while provide insignificant weak explanation to the changes in firms’ performance measured by Tobin’s Q. The insignificant results obtained from the use of the market-based performance measure could be related to the year of study, 2008, in which the global economic crisis took place.

Therefore, the paper argues that the market-based performance measures are objective ones under normal economic circumstances while the accounting-based performance measures are better ones in the years where unstable economic conditions exist. The results show that voluntary disclosure, CEO duality and board size are significantly influencing the UAE firms’ performance measured (ROE and ROA), while none of the governance variables significantly affect firms’ performance measured by Tobin’s Q. Furthermore, the results reveal that firm size is the only control variable that significantly influences firms’ performance. While other variables, such as board committees, audit type, industry, auditor type, leverage and listing years, are not significantly affecting firms’ performance. The results indicate that the principles of corporate governance which was originated from developed countries are also applicable in other countries. The findings agree with Stanwick and Stanwick (2010) study that the importance of governance will be diminished in the eyes of managers and shareholders if the level of corporate governance does not affect the financial performance of a firm. One of the paper limitations, due to the lack of data, is that it was not possible to measure the board committees’ effectiveness using the proportion of internal and external members, members’ experience and education, number of annual meetings, the number of independent members and other agency variables related to firm’s ownership structure. Another limitation is that the study paid more attention to internal governance mechanisms (CEO duality, board committees, disclosure and board size) while incorporating auditor type as the only external governance mechanism. Therefore, future research is recommended to investigate the influence of external mechanisms on firms’ performance. Finally, the study is cross-sectional. Further research is recommended to carry out longitudinal studies that examine the influence governance mechanisms on firms’ performance over a period of time. Nevertheless, the paper findings indicate that the underlying principles of corporate governance are applicable in emerging markets. The findings are important to regulators, investors, managers and researchers to contribute in developing new policies that establish better legal and regulatory infrastructure to increasing investors’ confidence and attracting foreign investment. The insignificant results of some corporate governance mechanisms and firms’ performance illustrate the additional challenges that emerging market economies have to face in order to implement the high standards of corporate governance and promote new regulations of governance. Note 1. The paper uses SPSS software in order to perform the statistical analysis. References Aljifri, K. and Moustafa, M. (2007), “The impact of corporate governance mechanisms on the performance of UAE firms: an empirical analysis”, Journal of Economics and Administrative Science, Vol. 23 No. 2, pp. 72-94. Al-Razeen, A. and Karbhari, Y. (2004), “Interaction between compulsory and voluntary disclosure in Saudi Arabian corporate annual reports”, Managerial Auditing Journal, Vol. 19 No. 3, pp. 351-360.

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About the authors Mostafa Kamal Hassan is an Associate Professor in Accounting at the University of Sharjah, UAE. He is currently on leave from Alexandria University, Egypt. He received his PhD from University of Essex, UK in 2003. He worked at the University of Hertfordshire, UK and University of Portsmouth, UK. He has published in Journal of Accounting & Organizational Change, Managerial Auditing Journal, Research in Accounting in Emerging Economies and Journal of Financial Reporting and Accounting. He is a member of the editorial board for International Journal of Behavioural Accounting & Finance. His research interests include the sociological analysis of accounting practices, institutional theory and accounting change, risk disclosure and corporate governance. Mostafa Kamal Hassan is the corresponding author and can be contacted at: [email protected] Sawsan Saadi Halbouni is an Assistant Professor at the University of Sharjah.

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