Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
Board Characteristics and Investment Efficiency: Evidence
from Egypt
Ahmed Sayd Rasheda and Ebtehag Mostafa Abdel Rahmanb
This paper examines the relationship between board of director's characteristics (board
size, board independence and Leadership structure) and investment efficiency in a
sample of 35 firms listed on the EGX100 in the Egyptian exchange securities for the
period 2006-2013 using panel data analysis. The results show that board size has a
significant negative relationship with investment efficiency. In contract to our expectations
the number of independent directors has a significant negative relationship with
investment efficiency, but insignificant with leadership structure. These finding imply that
the request for a minimum number (one-third of the board) of independent directors on
the board by decreasing information asymmetry and facilitating the monitoring of
investment decisions.
Keywords: board of director's characteristics, investment efficiency, panel data
analysis.
1. Introduction
The Financial crisis showed high weakness features in the financial control systems,
which lead to spread financial, accountancy and managerial corruption as a result
executive manager's overriding on firm performance and utilization to achieve private
shareholders. High firms restored to use loans to cover lower revenues and financing
activities, which lead to bankruptcy high firms in the 2000 year as a resulting weakness
internal control mechanisms so, require the need to develop internal mechanisms to
control in the firm (Kim and Nofsinger, 2007).
Prior studies indicate that the problems of asymmetric information and agency have a
major impact on the investment efficiency (Chen, 2012) due to a conflict the interests
between shareholders and a majority of managers and also a conflict between a
majority and minority shareholders which reduce the efficiency of corporate investment.
agency problem is one of a major part in the economic literature that attempt to
eliminate the conflicts between the interests of managers and shareholders, which that
the payout cash to shareholders reduce the available resources to the control of
managers, which reduce the strengths of managers and then increasing the likelihood
that incur these managers a monitoring task of the capital markets when the firm
obtains a new capital (Jensen, 1986).
Board characteristics are important internal mechanisms of corporate governance
(Fama and Jensen, 1983: Jensen1993). Board characteristics consist of three
mechanisms: board size, board independence and leadership structure. Fama and
Jensen (1983) argue that boards are controlled by the executive and independence
managers. Independence managers are able to a monitoring to avoid manipulating
_________________________________________________________
a
b
College of Business, Cairo University, postcode 12613, Egypt.
College of Business, Cairo University, postcode 12613, Egypt.
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
earning and then contribute with increase incentives. The remainder of the paper
proceeds as follows. In Section 2. We review the literature and discuss our research
hypotheses. Section 3 describes the sample and summary statistics. Section 4 presents
our main results and Section 5 provides the final section concludes.
2. Literature Review and Hypothesis Development
Many studies showed that board characteristics deal with agency problems through
implementing efficient investment decisions and also improve firm performance (Chen, 2012).
Those mechanisms include board size; board independence and leadership structure .We discuss
how each mechanism effects on investment efficiency in the Egyptian stock market.
2.1. Board Characteristics
2.1.1. Board Size
Theoretical studies refer to the important role that played board of directors in the decision
making and then may affect to the quality of the managerial decisions (Fama and Jensen, 1983).
Smaller boards should hold of non-executive directors because these directors enjoyed with
independence, ability to control on executive managers, ability to protect the interests of
shareholders and improve the financial performance for a firm (Yermack, 1996). Smaller boards
may reduce from rushing in the decision making, which diversified firms with smaller boards are
more likely capital allocation (Chen, 2012).
Small boards are Supervisory function relatively better compared to large boards (see: Beasley
(1996), Xie et al. (2003), Kao&Chen (2004), Jensen (1993), Yermack (1996), Eisenberg et al.
(1998) , Beiner et al. (2004). While Large-sized boards will reduce the duties of the Board of
Directors of the difficulty of achieving coordination and decision - making and effective
communication between the board members (see:Kao and Chen (2004), Lipton and Lorsch
(1992) and Jensen (1993). But some of the other studies that indicate that there is a large-sized
boards are better, such as: Pearce and Zahra (1991) that focused on Large size board to help in
strengthening the relationship between the environment and corporate firms as well as providing
advice on strategic alternatives where you play a critical role in the creation of the company's
corporate identity.
Boone et al (2007) explained the relationship between board structure and capital expenditure,
this study showed that Board size related to a negative relationship with value firm and increase
capital expenditures and also showed that independence board decrease with increase value firm
and capital expenditures. This study suggests that large firms are working in various fields
require investment decisions are valid to accuracy and then ratification from managerial boards
are the most developed to be in frequent with diverse industries. This confirms the correctness
that diversification firms are composed of higher boards and then increase investment efficiency.
Cheng (2008) study differs from other studies that highlighted that firms have higher boards
become lower volatile with performance. This study concluded that increase board size with
decrease value of the firm. While Yermack (1996) study agreed with theories that seen small
boards are the most effectively via use Tobin's Q as an indicator for evaluation market. This
study has evaluated financial and legal studies to decrease board size from managers so, showed
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
that board size related negative relationship with firm value (see Cheng, 2008; Boone et al.
2007).
Criticized both Lipton and Lorsch (1992) and Jensen (1993) higher firms' performance that refers
to disconnect problems and decision making Overshadowed the effectiveness of the board of
directors. The results indicate that board size has a strong negative impact on firm value (see
Yermack. 1996; Cheng, 2008; Boone et al. 2007). The negative relationship appears between
board size and firm value in a convex shape which indicates a large proportion of the lost value
in small and medium board size. This study confirms on that there is no evidence consistent with
the belief argues that firms changed boards' size caused firm performance in last.
Chen and Najjar (2012) study have conducted in order to determine the relationship between
board size and financial indicators such as: firm size, firm age and firm value. The results
indicate that board size has a negative relationship between board independence and firm value
and also a positive relationship between board independence. The authors found that board size
is significantly positively correlated with firm size. According to this study board size is not
relationship from both leverage and firm age. This study has highlighted about the percentage of
non-executive managers in Chinese firms which committed increase the percentage to 33% in
the 2003 year as a result Chinese firms committed with a legal framework for governance, but
this compulsory condition has effects of complex for instance: firms have implemented just to
cram so, its performance become non effectiveness, which leads to finding the governance
problem through the non active role for non-executive managers.
Lin et al. (2004) study examine determines board structure through trade off additional
information about factors that impact on firm value, extra coordinators expenses and free rider
problems in a large board size. This trade off differs between firms, industries and also optimal
board sizes. This study argues that future expectation about firm size and growth opportunities is
one of the most important limitations from board structure. This study argues that board
structures are determined simultaneously with ways conducted from value maximization. The
results indicate that board size has that board size has a positive impact on firm size and also a
negative impact on growth opportunities, but there is no relationship between board size and firm
performance;. Hence, based on the above discussion we hypothesize the following:
Hypothesis 1. There is a negative relationship between board size and investment efficiency.
2.1.2. Board Independence
Independence boards is a Significance for companies that want to pursue administrative
decisions issued by the board of directors effectively, and there is scientific evidence to support
the importance of the independence of the Board of Directors Examples of such studies: Byrd
and Hickman (1992), Rosenstein and Wyatt (1990) that Indicate that the proportion of nonexecutive directors and independent on the board more effective in the evaluation of the
executive management of the company, Where defiance of managerial discretion. Whenever the
greater the proportion of non-executive directors led to increased financial performance of
companies. There are some other studies such as: Agrawal and Knoeber (1996), Franks et al.
(2001), Chen and Najjar (2012) that believes that boards of directors dominated by nonexecutives directors are ineffective due to lack of available information they have about the
company and they do not have the skills required to perform these tasks.
Anderson et al. (2000) study examines board structure in diversification and concentrated firms.
The results indicate that diversification firms are high level of independence which leads to be
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
more effective in monitoring managerial decision and enhance its value so. Investment decision
is the most efficient for diversification firms by giving further of independence for board of
directors.
Mashayekhi and Bazaz (2008) study investigates impact corporate governance mechanisms on
firm performance in Iran. This study confirms found a negative relationship between board size
and firm performance (see: Lipton and Lorsch, 1992; Jensen, 1993; Cheng, 2008; Boone et al.,
2007; Yermack, (1996). this study pointed out that there is no relationship between leadership
structure and firm performance and also no relationship between institutional ownership and firm
performance. the results refer to that independence board increase with higher firm performance.
This study indicates that Islamic culture in Iran can impact on those results.
Müller (2014) study is one of the academic literature that indicate the relationship between
corporate governance and financial performance, which showed results that independence board
related with a strong positive relationship with current or future firm performance (see:
Mashayekhi and Bazaz, 2008; Anderson et al., 2000) .
Guo and Kumara (2012) examine the relationship between corporate governance mechanisms
and firm performance in the Colombo Stock Exchange in Sri Lanka. The results indicate that non
executive managers related to a negative relationship with firm value rather than this relationship
is not significant and also found a negative relationship between non executive managers and
firm performance while there is no relationship between leadership structure and firm
performance.
Agrawal and Knoeber (1996) study have review chose the firms to mix from mechanisms that
use to eliminate agency problems between managers and shareholders. This study showed that
there is a negative relationship for both outside directors and a debt ratio with related to firm
performance. This study supported found a negative relationship between compost board of
directors and firm performance because the board of directors involved with lots of outside
directors.
Kumar and Singh (2013) supported a negative relationship between board size and firm value
and also confirm that this relationship declines with large firms compared with small firms. This
study has progressed, evidence of a negative relationship between board independence and firm
value which indicate that Indian firms suffer from the problem of financial distress as a result
financial crisis. Large Board of directors has not been able to important strategic decision
making caused the problems of coordinating and connecting which, lead to decrease firm value.
Hence, based on the above discussion, we hypothesize the following:
Hypothesis 2. There is a negative relationship between board independence and investment
efficiency.
2.1.3. Leadership Structure
Leadership structure means separation between CEO and chairman authority which lead to
impact positively on board effectiveness. Fama and Jensen (1983) indicate that from the
perspective of agency problem that leadership become ineffective in the case of combining
between chairman and CEO roles which, CEO played by chairman role has been impacted
negatively on firm value (Bai et al., 2004).
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
Brickley et al. (1997) indicate that from the common perspective from the leadership structure
through some of academics and financial report's analysis and organizers whose, it is the best
separate between the chairman and CEO positions instead of combining for both it. There are 2025% of the American firms supported separate between each position which, lead to increase
firm value. Dual leadership agreements are ignoring separation costs between CEO and chairman
positions which, it included agency problems to control in chairman behaviour and information
costs and exchange firms for consequence operators in addition to other costs such as: conflicted
decision making with common authority. There isn't evidence from the theoretical background
that leadership structure is better rather than from the reality indicate that it is probably differed
the optimal leadership structure by various economic conditions that faced the firm and also
asymmetry information costs related to separation between each position as an important
limitation for a leadership structure due to decrease agency problem and asymmetry information
costs. Legislative reforms forced firms to separate between each position, but these legislators
are deceptive legislated because it is a necessity to estimate benefits and costs of alternative
leadership structures before reaching for a lot of final conclusions.
Goyal and Park (2002) study indicate the CEO role and its effects on firm performance, which,
CEO role and its effects become much less when CEO and chairman become at the same person,
hence, this study consistent with the belief that the lack of independent leadership in firms that
combine the position of executive directors and chairman which, it makes it difficult for the
board improve firm performance Brickley et al. (1997).
Lin and Zhao (2006) suggested combing the positions of executive director and chairman of the
same person. Although the combination of the two posts contributes effectively in diversified
firms, but the chairman may miss the required expertise in industrial fields carried out by those
firms.
Bekiris (2013) Supports the idea of dual ownership structure and based on the separation
between Chairman and Chief Executive Officer roles in order to increase board independence.
The results showed that a negative relationship between board size and board independence,
which, this result is contrasted in agency problem that considers that manager entrenched for
themselves by adopting the idea, large boards. This study supported the small board because it is
the most independence comparisons of large boards, therefore, eliminates agency costs.
Brigham&Ehrhardt (2005) indicate that shareholders seek to maximize the wealth while seeking
managers to achieve their own goals and then if did not happen consensus between the interests
of shareholders and managers, it will not be to maximize firm value and as a result of the conflict
of interests produces Agency problems where the managers do with their own interests by using
the assets of an entity for the benefit of the expense of shareholders as well as the manipulation
and fraud in estimating the assets of an entity which leads to the emergence of agency costs.
Hence, based on the above discussion we hypothesize the following:
Hypothesis 3. There isn't relationship between leadership structure and investment efficiency.
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
3. Research Method
3.1 Sample
The sample frame is comprised of all firms listed on the EGX100 in the Egyptian stock market
during the period 2006-2013. The dataset consist of 213 firms listed on the EGX100 (32 firms
outside the cabin). The final sample consists of 35 firms due to missing relevant information
about CGM over the period.
3.2 Measurement of variables
3.2.1 Investment efficiency
Our Investment proxy, Capex means average future investment for each sample year, which
Capext+1 defined as capital expenditures scaled by lagged property plant and equipment. This
measure ignores other types of non-capital investments such as research and development, but it
has been widely used in previous research (Lara et al. 2009)
3.2.2 Independent variables
Board size is a number of directors serving on the board. Board independence is a Fraction of
outside directors on the board, where outside directors are directors who do not have an
executive position in the firm, have not had such a position in the past, or are not related to an
executive. Leadership structure is a Dummy variable that equals one when the chairman of the
board also serves as CEO, and zero otherwise.
3.2.3 Control variables.
We control for other determinants of Investment efficiency identified in the existing literature
that is firm size, debit ratio and Tobin's Q measured as follows:
- Firm size is the log of total assets (Log Asset).
- Debit ratio is the ratio of total debt to total assets.
- Tobin's Q is the ratio of the market value of total assets to the book value of total assets.
3.3 Statistical analyses
The regression model utilized to test the relationship between the board characteristics and
Investment efficiency is as follows:
Capext+1= α + β1 BS + β2 BI+ β3 LS + β4 FS + β5 DR + β6 Q +εt+1
Where, Capext+1 = capital expenditures scaled by lagged property, plant and equipment; BS
=board size; BI = board independence; LS = leadership structure; FS = firm size; DR = debit
ratio; Q = Mkt-to-Book and ε = error term.
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
4. Findings
Table 1 reports the descriptive statistics of investment efficiency and the independent variables.
The mean of investment efficiency (Capext+1) of prior years' property, plant and equipment
across all firms throughout the study period is 1.86 which isn't consistent with figures reported
by Biddle et al. (2008) and Lara et al. (2009) .The average of investment efficiency listed firms
in this study is low compared to the findings by Biddle et al. (2008) and Lara et al. (2009). The
table also shows that the average number of directors on the board (BS) in the Egyptian firms is
9 which is consistent with study Chen and Al-Najjar (2012). The mean of board independence is
0.53 which refer to half of board of directors consists of non-executive mangers that is consistent
with prior studies (Müller (2014), Mashayekhi and Bazaz (2008) and Anderson et al. (2000). The
mean for leadership structure is 0.54 which conflict with governance rules in Egypt.
Table (1) Descriptive statistics
Variables
N
Min
Max
Mean
SD
Capex
279
0.10
266.2
66..
26.2
BS
279
5.00
606..
86..
26.6
BI
279
0.20
.6..
.660
.660
LS
279
0.001
66..
.660
.66.
FS
279
7.22
6.68.
8668
.6..
DR
279
0.02
66600
6600
668.
Q
279
0.21
006.6
2620
06..
Table (2) Regression results
Dependent Variable: INV
Method: Panel Least Squares
Sample: 2006 2013
Periods included: 8
Cross-sections included: 35
Total panel (unbalanced) observations: 279
Variable
Coefficient
Std. Error
t-Statistic
Prob.
Constant
BS
BI
LS
FS
DR
Q
-0.88
-0.21
-3.59
0.09
0.71
-0.05
0.04
1.99
0.06
1.22
0.31
0.21
0.08
0.04
-0.44
-3.57
-2.94
0.30
3.28
-0.69
1.05
0.65
0.00
0.00
0.76
0.00
0.48
0.29
Adjusted R square: 0.07; F-stat: 4.54; Sig.: 0.000
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
The results presented in Table 2 show that the regression model is significant (F=4.54, P<0.000)
with an adjusted R square of 0.07. The table (2) reveals that there is sufficient evidence to infer
that there is a linear relationship between all measures of board characteristics and Investment
efficiency across all listed firms during the period study.
We find evidence that board size is negative and significant associated with investment
efficiency (BS= -0.22, t-stat =-3.57) which these finding consistent with prior studies (Lipton
and Lorsch (1992) , Jensen(1993), Cheng (2008) , Yermack (1996) , Kumar and Singh (2013),
Boone et al. (2007) and Mashayekhi and Bazaz (2008) in contrast there are some studies
interfered with that result (Lee and Chen (2011) , Chen and Najjar (2012) . the coefficient of
board independence is negative and significant related to investment efficiency(BI= -3.59, , tstat= -2.94) and then these result are consistent with Agrawal and Knoeber (1994) , Guo
and Kumara (2012), Kumar and Singh (2013) but these finding conflict with Müller (2014) ,
Chen (2012), Anderson et al. (2000) .
Leadership structure does not influence of investment efficiency (LS= 0.09, t-stat= 0.30). This
finding is similar to the findings by Brickley et al. (1997), Bai et al. (2004), Goyal and Park
(2002), Guo and Kumara (2012) and Mashayekhi and Bazaz (2008) which that the best
leadership structure probably differs according to economic conditions facing the company, and
that there is no independent leadership to the Board of Directors will improve the company's
performance and thus increase investment efficiency.
The regression results also show that the relationship between the control variables and
investment efficiency., However, the coefficient is positive, suggesting that there is significant
positive relationship between firm size and investment efficiency ( FS = 0.71 , t-stat = 3.28)
which these findings are supporting with prior studies (Boone et al. (2007) and Chen and Najjar
(2012) . in contrast debt ratio is insignificant related with investment efficiency although the
coefficient is negative (DR=-0.06,t-stat= -0.69) and also market to book (Tobin's Q) is
insignificant rather than positive (Q=0.05 , t-stat=1.06) .
5. Conclusion
This study provides evidence that board characteristics have a negative impact on investment
efficiency Which imply that the request for a minimum number (one-third of the board) of
independent directors on the board by decreasing information asymmetry and facilitating the
monitoring of investment decisions; (2) by increasing managerial incentives to throw over poorly
performing projects earlier .Using 35 firms listed on the EGX100 for the period 2006-2013. The
results showed that board size influenced negatively on investment efficiency and also board
independence has negatively impact on investment efficiency. Leadership structure isn't impact
on investment efficiency. Our results suggest that board characteristics improve investment
efficiency.
Proceedings of 34th International Business Research Conference
4 - 5 April 2016, Imperial College, London, UK, ISBN: 978-1-925488-02-9
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