Corporate Governance and Firm Performance Relationship

Abstract

The paper at hand is devoted to the examination of the interconnection between corporate governance and firm performance. The relevant problem has been widely discussed throughout the past decades; thus, there is a large scope of scientific analysis that studies it from different perspectives. The key target of the relevant research resides in identifying the character of the mentioned interconnection as well as identifying the principal mechanisms of the influence that corporate governance has over firm performance. The research has a qualitative design and aims at providing a general outline of the problem rather than examining its specific aspects. The research findings show that the influence of corporate governance on firm performance is explained by the fact that the former determines largely the firm’s decision-making and the investors’ vision, which, in their turn, shape the character of the performance. The key aspects that reflect the impacted performance are the return on assets and the return on equity. Meanwhile, there is no consensus regarding the beneficial conditions in terms of corporate governance that could assure successful performance. As a result, it is recommended that further studies focus on this aspect as well as on examining the relevant problem in connection to a particular market.

Introduction

Corporate governance largely determines the directions for the business processes and management strategies. It regulates the relationships between the controlling parts, defines the roles that the directors and shareholders are supposed to perform. The relevant problem has been widely studied throughout the past decades. Hence, whereas the impact of corporate governance on a firm performance would be questioned at the end of the twentieth century, today, a large evidence base exists proving the existence of such interconnection. Even though all the researchers have their approach to treating the problem, the majority of them focus on the fact that corporate governance is tightly bound with investors. From this perspective, the relationship between corporate governance and firm performance becomes evident: the former has a significant impact on the investment climate and thus, on the performance in general.

It is important to note, that the majority of specialists agree upon the point that sustainable corporate governance has a positive effect on the firm performance. Hence, Gupta and Shamra (2014:5) claim that efficient corporate governance is highly assistive in enhancing the economic prospects of a firm, reducing risks, and attracting investors. Meanwhile, how corporate governance is organized varies in different countries, according to their economic, political, and social contexts. Thus, for example, Gupta and Shamra (2014:11) point out the fact that the dominance of chaebols in Korean corporate governance hurts firm performance making the entire system less transparent and flexible.

Hence, the paper at hand is mainly aimed at examining the key mechanisms of the influence that corporate governance has over a firm performance. The research relies on the literature analysis and the case studies provided by the recent research. Apart from defining the interconnection between corporate governance and firm performance, it is considered critical to indicate those aspects of performance that are more susceptible to the governance’s impact. The following paper does not set an aim of investigating a particular market; instead, it focuses on finding the general consistent patterns that exist in the framework of the analyzed problem. It is expected that the study will provide some evidence for the assumption that good corporate governance has a positive impact on a firm’s performance.

Literature review

The problem of interconnection between a corporate government and a firm performance is widely discussed in the literature. For instance, Pooja Gupta and Aarti Mehta Sharma (2014:5) address this issue in the framework of Indian and South Korean markets. The researchers point out the fact that the extent of the influence that the government has over a firm’s operation is determined by the local environment so that it varies according to certain governmental practices. As a result, there is no consistent pattern that would be relevant to any region. According to Gupta and Sharma’s findings, India pursues a more rigorous corporate governance policy that is mainly based on the principles of the US model contrary to South Korea that sticks to the stakeholder form. They highlight a significant difference in mandatory disclosures in these countries. Even though South Korea tries to implement some corporate government legislations, it still doesn’t have any exclusive requirements concerning independent directors and relevant committees, due to the consistent authoritative power of chaebols.

Another critical idea that Gupta and Sharma (2014:9) elucidate is the interconnection between governmental practices and the share pricing policies. Thus, their study shows that, from the pricing perspective, the impact of corporate governance practices is very limited in any country.

Whereas, Gupta and Sharma provide a general overview of the problem, Vo and Nguyen (2014:10) focus on more specific aspects of the corporate government’s impact on firms’ performance in the framework of the eastern market. They put a particular emphasis on the inner organizational structure of the corporate government about firms’ performance. According to their findings, the structure of CEO duality, which implies every CEO acting as a chairperson, has a positive impact on firm performance.

In the meantime, the idea of interconnection between the corporate governance structure and firm performance is argued by Azizah Abdullah and Michael Page (2009:78) that study the relevant problem within the European market. The researchers’ findings show that firm performance is more likely to depend upon some economic factors rather than on the board size or directors’ holdings.

Design

As long as the relevant study is mainly aimed at defining some general relations that exist between corporate governance and firm performance, the research design is qualitative – hence, the principal data collection tool is literature analysis, and the deductive approach is employed to perform the data analysis.

Hypothesis

It is assumed that there is a strong connection between corporate governance and firm performance – the efficient organization of the former is likely to have a positive impact on the latter. To test the advanced hypothesis, the relevant research aims to answer a series of questions:

  1. What are the main mechanisms of the impact that corporate governance has on firm performance?
  2. What are the essential conditions that guarantee a positive impact?
  3. What aspects of firm performance are the most susceptible to the influence of corporate governance?

Findings

The analysis of the relevant literature and case studies has provided a series of findings that will be divided into three sections by the questions posed at the beginning of the research.

First and foremost, the principal mechanism of influence is similarly defined by all the researchers. Thus, there are two main ways in which corporate governance is likely to influence firm performance. Firstly, it is responsible for critical decision-making and determines its efficacy. Secondly, the way the corporate governance behaves influences largely the image of the company and the investors’ willingness to collaborate.

Secondly, there currently is no consensus regarding the characteristics of a corporate government that would guarantee its positive impact on firm performance. These conditions vary in different markets. Thus, the UK researchers, Abdullah, and Page (2009:72) point out that excessive independence of the corporate government has a negative influence on firm performance. In the meantime, they indicate an optimal size of the board – between seven and eight members – that assures the most productive decision-making and, thus, the best performance. In the meantime, Gupta and Sharma (2014:9) point out the independence of corporate governance as the key determinant of a successful performance. All the researchers, including Vo and Nguyen (2014:11), agree on the point that the duality of the structure of corporate governance, as well as its moderate size, represents beneficial conditions for firm performance.

Finally, all the researchers agree on the point that the key aspect of the performance that is the most susceptible to the influence of the corporate governance is its return on assets and return on equity as they are the most reliable indicators of the operational efficacy.

Discussion

The general research of the indicated problem has helped to collect some valid evidence of the advanced hypothesis. Thus, the recent studies prove the fact that there is a strong interconnection between corporate governance and firm performance. Moreover, the research has assisted in indicating the aspects of firm performance that are most relevant about the corporate governance’s impact. In the meantime, the question of the positive characteristic of corporate governance that could guarantee a successful performance remains unclear. Hence, the relevant research might be potentially extended to define these characteristics as well as to indicate the role of the local environment on corporate governance.

Conclusion

The relevant research shows the importance of corporate governance’s efficacy and reasonability in terms of firm performance. Even though the character of this interconnection proves to vary in different countries, the key idea resides in the fact that corporate governance is the principal determinant of the decision-making process and, thus, of the investment climate, in general. Whereas the main mechanisms of the impact are clearly defined, the analysis of the relevant literature shows that some of the aspects related to the problem are still poorly examined. Thus, for example, there is, currently, no empirical data regarding the beneficial conditions in terms of corporate governance that would guarantee a successful company’s performance. It might be assumed that these characteristics can vary by the peculiarities of the local environment. As a result, it is recommended that the relevant research be further extended to examine the specific aspects of the selected problem.

Works Cited

Abdullah, Azizah, and Michael Page. Corporate Governance and Corporate Performance: UK FTSE 350 Companies, Edinburgh: The Institute of Chartered Accountants of Scotland, 2009. Print.

Gupta, Pooja and Aarti Mehta Sharma. “A Study of the Impact of Corporate Governance Practices on Firm Performance in Indian and South Korean Companies.” Procedia – Social and Behavioral Sciences 133.6 (2014): 4-11. Print.

Vo, Duc Hong and Tri Minh Nguyen. “The Impact of Corporate Governance on Firm Performance: Empirical Study in Vietnam.” International Journal of Economics and Finance 6.6 (2014): 1-13. Print.

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