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Corporate Governance and Firm Performance in Iran
Article in Journal of Contemporary Accounting and Economics · December 2008
DOI: 10.1016/S1815-5669(10)70033-3
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Research Note
Corporate Governance and
Firm Performance in Iran
Bita Mashayekhi"' and Mohammad S . B a z a z b *
"University of Tehran
hOuklund UniversiQ
Received March 2008; Accepted November 2008
Abstract
This study uses data from companies listed in the Tehran Stock Exchange (TSE)
for the years 2005-2006 to investigate the role of corporate governance indices on firm
performance. We use board size, board independence, board leadership and institutional
investors on the board as corporate governance indices and EPS, ROA and ROE as firm
performance surrogates.Our regression results show that board size is negatively associated
with firm performance. Moreover, the presence of outside directors strengthens the firms'
performance. We find, however, no relationship between leadership structure and firm
performance. Likewise, the presence of institutional investors on the board of directors is
not positively associated with firm Performance.
JEL Classijcations: L25, M40,G30
Keywords: Islamic economy, Iran, corporate governance, firm performance, board of directors,
institutional investors, leadership structure
1. Introduction
The literature on the relationship between corporate governance and firm performance
is extensive. However, the findings are inconclusive. One literature stream finds that corporate governance is positively associated with firm performance whereas other studies show
no such linkage. The literature that shows a positive correlation is based on the theory
*
The authors acknowledge the valuable comments from the editor and anonymous referees.
Bita Mashayekhi and Mohammad S . Bazaz
157
Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 156-172
that an efficient board of directors can significantly reduce agency costs. Following this
line of reasoning, Brown and Caylor (2004) find a strong correlation between corporate
governance and performance, valuation and dividend payout for a large sample of US
firms. Similarly, Lee et al. (1992) observe that stockholder wealth increases in management buyouts when outside directors are in charge. Weisbach (1988) also finds that CEOs
are more likely to quit due to poor firm performance when faced with outside directors.
Beasley (1996) shows that the likelihood of financial statement fraud is reduced when a
firm has outside directors and an audit committee. Along similar lines, Denis and Sarin
(1999) find that firms would have above-average stock price returns if they substantially
increased the proportion of independent directors.
In contrast to these studies, some others fail to show a positive association between
dimensions of corporate governance and firm performance. Larcker et al. (2007), for example, discover that the association between corporate governance and firm performance
is inconsistent although they concede that their findings may result from difficulty in
identifying reliable and robust measurements of corporate governance. In a meta analysis
of studies related to board effectiveness, Dalton et al. (1998) conclude that CEO duality
and the insider/outsiderboard proportion have no direct relationship to firm performance.
Heracleous (200 1) reports that researchers have failed to find any convincing connection
between the best practices in corporate governance and organizational performance. Fosberg (1989) finds no linkage between the proportion of outside directors and various firm
performance measures (i .e ., selling,general and administrative expenses,revenues, number
of employees, and return on equity). Bhagat and Black (2002) also observe no relationship
between outside director proportion and either asset return or asset turnover. While Klein’s
(1998) research suggests that there is no relationship between overall board independence
and operating performance, the study shows that there is a significant relationshipbetween
insider presence on some (finance and investment)committees and operating performance.
Focusing on a different board of director characteristic, Yermack (1996) documents an
inverse relation between board size and firm profitability.
Although the correlation between corporate governance and firm performance is still
not clearly established, it is common business practice for firms to establish a board of
directors to monitor business performance, thereby protecting the company’s shareholders (Kosnik, 1987, 1990). In addition, the dynamics and development of the corporate
economy in developing countries is often different from those in countries with more
developed economies, such as the US and the UK. Basic legal systems, political stability,
smaller market size, corporate ownership and the nature of individual financial systems
are examples of the differences in the institutional arrangements between developed and
developing countries (see Gul and Tsui, 2004). Evidence of the financial impact of corporate governance on firm performance in developing countries is still relatively scarce. The
few studies that are available in developing countries have produced mixed results. For
example, Chang and Leng (2004) demonstrate that firm performance among companies
in Malaysia has a negative association with board independence, duality, concentration
of ownership and leverage. They, however, find board size and institutional investors on
the board have a positive impact on firms’performance. On the other hand, Xu and Wang
(1999), using Chinese company data, find a positive correlation between ownership concentration and firm performance.
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Journal of Contemporary Accounting & Economics Vol4,No 2 (December 2008) 156-172
158
The present study explores the relationship between board characteristics and firm
success in another developing country, Iran. Iran was selected because, from an institutional perspective, it differs substantially from the two developing countries (China and
Malaysia) mentioned above.
Iran, located in the Middle East, a politically troubled and unstable region of the world,
has unique environmental characteristics. Searching through the ABI-Inform database, we
were unable to find a related study for surrounding countries, such as Saudi Arabia, Kuwait,
Jordan, Egypt, or Syria. Moreover, Iran is a strict Islamic country. As a result, its social
and business activities are based on fundamentalist religious laws and regulations. The
1979 Iranian Revolution altered its people’s social values and corporate culture. When
selecting or promoting high-ranking officers and board members, Iranian firms place
significant emphasis on the officers’ faith and acceptance of traditional Islamic customs.
This emphasis is different from countries where specialization, education level, or political
affiliation guides the board selection process. In addition to the role of religion, the origin
of Iranian civil law influences corporate governance. Iranian civil law, which is a synthesis
of French and Belgian civil law, provides relatively weak legal protection for shareholders
and creditors and is characterized by dispersed firm ownership, increased corruption, and
less financial statement transparency (LaPorta et al., 1998).
Unlike countries with more developed economies, the main objective of Iranian
businesses does not appear to be creating wealth for the shareholders.In Iran, there is a more
nuanced objective based on Islamic Shariah Law. Iran offers a promising environment in
which to explore the relationship between corporate governance and firm performance.
The remainder of the paper is divided into four sections. Section 2 discusses corporate
governance in Iran, reviews the related literature and develops the various hypotheses for
testing. Section 3 describes the research design. Section 4 provides our empirical results.
Finally, a summary of our results and an overview of our conclusions are presented in
Section 5 .
2. Background and Hypothesis Development
2 .I Corporate governance in Iran
Corporate governance in Iran is not yet well developed, but in the last few decades
the government has taken some steps to make marginal improvements. The Tehran Stock
Exchange (TSE) was established in early 1967. The process of instituting and controlling
firms is briefly addressed in the Iranian Trade Law, particularly in its April 1968 amendment.
A modem concept of corporate governance was not recognized in Iran, however, until the
government sought to improve the competitive position of Iranian companies in the world’s
capital markets in an attempt to attract foreign investment. In early 2000,the management of
the TSE, the Islamic Parliament Research Center and the Economic and Finance Ministry,
began efforts to improve at least on paper, corporate governance in Iran.
Until recently, the Iranian government controlled the majority of businesses in Iran,
either directly or indirectly, and has made significant efforts to expand the capital market.
Its actions indicate an interest in enhancing the current system to include external gov-
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Journal of Contemporary Accounting & Economics Vol4,No 2 (December2008) 156-172
ernance structures. For instance, the Third and the Fourth Economic Development Plans
place a great deal of importance on the privatization of governmental organizations.Recent
policies have also been aimed at increasing the number of external control mechanisms
in place. Currently, Iranian firms still have weak internal and external corporate governance when compared to companies in industrialized nations. The capital market in Iran
is new and somewhat inefficient. Pension funds, mutual funds, and insurance companies
now own more than half of the share value of publicly traded stocks on the TSE. Major
shareholders, including institutional investors, exercise their supervision by controlling
management decisions and by appointing executives according to their whims and fancies.
Unlike that of majority shareholders, minority shareholders’ interests are not protected
in contrast to other countries where non-controlling shareholders sometimes exercise
significant influence. No Iranian institution ranks firms based on such characteristics as
revenue, income, total assets, number of employees, etc. Iran’s internal control supervision
mechanisms are also inadequate. In general, organizational roles and responsibilities are
poorly defined and communicated. As a result, employees too often place personal gain
and interest ahead of corporate interest. Nevertheless, and despite the noted inefficiencies,
public companies registered on the TSE are required to have their financial statements
reviewed by an external auditor.
In late 2004, the TSE Research and Development Center published the first edition
of The Iranian Code of Corporate Governance. This code consisted of 22 clauses, which
included the following: definitions of key terminology, an overview of the management
board and shareholders’ responsibilities, guidelines for financial disclosures, and a conceptual framework for accountability and auditing. The code was amended in 2005 to
address issues of ownership structure, the capital market situation and the Trade Law. This
second edition of The Iranian Code of Corporate Governance contains five chapters and
38 clauses. Appendix A provides a summary of this updated version of Iran’s corporate
governance code. While the application of this code is not mandatory, many firms have
implemented it.
2.2 Literature review
The Asian financial crisis (1997-1998) significantly changed the landscape of corporate
governance in many affected countries, including Iran. One critical element of corporate
governance that has undergone reform is the structure of the board of directors. The primary objective of a board of directors is to protect the interests of a firm’s shareholders.
Thus, a board of directors is responsible for ensuring long-term shareholder value and for
evaluating the appropriateness of the approaches taken by management in pursuit of this
goal. To ensure effective implementationof corporate strategies,the board closely monitors
management performance and may offer rewards or assign punishment accordingly.The
board’s success in discharging its fiduciary duties and in working closely with management
is expected to increase the wealth of its shareholders.
The dispersion of ownership in modern corporations, which rely heavily on external
sources of capital, increases the importance of the board. Hence, owners are no longer
responsible for the direction and daily operation of the firm. Rather, a team of professional
managers, who at best own a small amount of equity, dictates the daily operations of the
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160
firm. This separation between ownership and control results in a potential conflict of interest in modern companies (Berle and Means, 1932). Agency theory proposes that when
management’s interest is low there is a greater likelihood that management involves itself
in value-decreasing activities (Jensen and Meckling, 1976).
In the next section, we develop hypotheses about the relationship between board
characteristics, such as board size, board independence, board leadership and institutional
investors on the board, and firm performance proxies, such as EPS, ROA and ROE. EPS
is measured as net income divided by total shares; ROA is measured as income before
extraordinary items divided by total assets; and ROE is measured as income before extraordinary items divided by total equity.
2.3 Hypotheses development
Board Size: Fama and Jensen (1983) point out that the most important function of a
board of directors is to control agency costs resulting from the separation of ownership and
control. Others, like Chaganti and Mahajan (1985) and Dalton et al. (1998), believe that
large boards are valuable for the variety of experiences the members bring to the board
decision making. They suggest that a larger board is more effective in preventing corporate
failure (see also Dallas, 200 1)
On the contrary, if the board size is large, board members may find efficient communication more difficult and consensus difficult to achieve. Lipton and Lorsch (1992), Jensen
(1993), and Beasley (1996) suggest that a small board of directors plays a controlling
function whereas a large board of directors will lack genuine interaction and debate, thus
increasing the CEO’s power. Likewise, Fuerst and Kang (2000) demonstrate that board
size is negatively related to firm value. In fact, a smaller board may be less encumbered
with routine problems and may provide better firm performance. We therefore hypothesize
that board size has a negative effect on firm performance:
Hypothesis 1 (HI): There is a negative relationship between board size and firm performance.
Board Independence: Fama and Jensen (1983) argue that the board of directors is the
most effective internal control mechanism for monitoring the behavior of top management.
However, existing literature examining the role of board structure on firm performance
yields mixed findings.
Conyon and Peck (1998) state that if outside directors either hold no shares or hold an
insignificant number of shares, their incentive to monitor management, and thus protect
shareholder interests, may be less. On the other hand, several corporate reformers have
concluded that independent directors and audit committees of independent directors will
enhance the audit process (e.g, Treadway Commission, 1987; Blue Ribbon Committee,
1999). Williamson (1985) argues that managers have an enormous informational advantage
because of their full time status and insider knowledge. As such, the board of directors
might easily become an instrument of management, thereby sacrificing shareholder interests.
While MacAvoy et al. (1983) and Hermalin and Weisbach (1991) report no significant
correlation between board composition and performance,Yermack (1996) and Klein (1998)
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suggest that a high percentage of independent directors leads to poor performance.
Based on the majority of interpretation, we propose that a high proportion of executives
on the board indicates strong monitoring. Therefore, we hypothesize that:
Hypothesis 2 (HJ: There is a positive relationshipbetween the proportion of independent
directors on the board and firm performance.
Board Leadership (CEO Duality): Jensen (1993) claims that CEOs who also hold
the board chair position (duality) exert undue board influence, compromising the strength
of the board’s governance. In fact, there is likely to be a lack of independence between
management and the board if the CEO is also the board chair. The issue of separation of
the two posts was addressed in the Cadbury Report (1991), which recommends that the
roles of the board chairman and the CEO should be separated. The Iranian Code of Corporate Governance (2005) also advises a similar board structure. When both the leading
role (i.e., the board chairperson) and the implementation role (i.e., the CEO) are vested
in a single person, the board’s monitoring function will be severely impaired. This board
independence impairment could affect its incentive to ensure that management pursues
value increasing activities.
Though the literature seems to consistently argue that separation of the CEO and the
chairman posts leads to better corporate governance, the real issue is whether this leads the
board to better monitoring and, thus, to increase firm value. While Berg and Smith (1978)
find no significant differences in various financial indicators between firms that experienced
CEO duality and firms that did not, Rechner and Dalton (1991) report that firms with CEO
duality consistently outperform firms with a CEO non-duality structure.
In this study, we consider CEO duality an indicator of weak firm performance. Therefore, we hypothesize that:
Hypothesis 3 (HJ: There is a negative relationship between CEO duality structure and
firm performance.
Institutional Directors: Large shareholders, such as institutional investors, have the
incentive to exercise control over management and the power to initiate change in the case
of poor performance. Institutional investors are large enough to exercise discretion over
the investments of others (Lang and McNichols, 1997). Many researchers propose that
corporate monitoring by institutionalinvestors can constrain manager behavior (McConnell
and Servaes, 1990; Smith, 1996; Del Guercio and Hawkins, 1999; Hartzell and Starks,
2003). In fact, large institutional investors have the opportunity, resources and ability to
monitor, discipline, and influence managers. McConnell and Servaes (1990) confirm that
institutional investor impact on firm valuation is generally positive.
Based on this evidence, we conclude that corporate monitoring by institutional investors
can force managers to focus more on corporate performance and less on opportunistic or
self-serving behavior. As a result, we hypothesize that:
Hypothesis 4 (HJ: There is a positive relationship between the presence of director(s)
from institutional investors on the board and firm performance.
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162
3. Research Method
3.1 Sample selection
This study’s sample comprises firms listed on the TSE for the years 2005 and 2006.
We exclude all financial firms (including banks) because this regulated industry is likely
to have fundamentally different cash flow and accrual processes. We also eliminate firms
with insufficient data to estimate dependant and independent variables. After adjusting for
outliers, the sample comprises 240 firm years. We hand-collected board composition and
other board characteristic data directly from annual reports or from company handbooks.
The financial and accounting data needed to compute firm performance indices are obtained
from TSE reports on CDs and from the Internet.
3.2 Data analysis
While market based measures tend to be more objective than accounting based
measures, they are also affected by many uncontrollable factors (Gani and Jermias, 2006).
Hutchinson and Gul(2004) argue that accounting based performance measures reflect the
results of management actions and are therefore preferable to market based measures when
investigating the relationship between corporate governance and firm performance. Prior
research (e.g., Hermalin and Weisbach, 1991; Shleifer andvishny, 1997; John and Senbet,
1998; Eisenberg et al., 1998; Fernandes, 2007) has linked corporate governance to firm
performance using some proxies for firm valuation, such as Tobin’s Q , ROE, ROA, EPS,
and annual stock return (RET). In this study, we use EPS, ROA and ROE as dependent
variables to measure firm performance.
We consider four characteristics of board of directors as core independent variables of
corporate governance (Fama and Jensen, 1983). They are (i) the number of directors on
the board (BSIZE); (ii) the proportion of independent directors on the board (BOUT); (iii)
CEO duality (DUAL), which indicates whether the CEO is also the chair of the board; and
(iv) the existence of directors on the board who are institutional investors (BIN).
We control for firm size (SIZE), leverage (LEV), and the number of years a given firm’s
stock has been traded on the TSE (AGE). A number of studies (e.g., Ramaswamy, 2001;
Frank and Goyal, 2003) have suggested that firm size might influence firm performance.
For example, Fama and French (1995) demonstrate that smaller firms, on average, have
lower ROE than larger firms. Accordingly, firm size has been used extensively as a control
variable in the empirical analysis of firm performance. We use the natural logarithm of
total assets as the indicator of firm size. Because leverage influences firm performance
through monitoring activities by debt holders, we measure it as total liabilities divided by
total assets. AGE, the length of time that the firm’s common stock has been traded on the
TSE, is another control variable in this study. We also included the industry effect in our
model (unreported).
We use multiple regression analysis (MRA) to find the association between the explanatory variables and firm performance (Hair et al., 1992;Weir, 1997). Correlation analysis is
used to assess whether multicollinearity does not exist among independent variables. The
following are the regression models used for testing Hypotheses 1-4:
Bita Mashayekhi and Mohammad S. Bazaz
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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 156-172
EPS, = a, + a, BSIZE,+ a, BOUT,+ a3DUAL,+a,BINS,+ a5LEV,+ a6 SIZE,
+ a, AGE,+ E,
(1)
ROAi = a, + a , BSIZE,+ a, BOUT,+ a3DUAL, + a4BINS,+ a5LEV,+ a, SIZE,
+ a, AGE,+ E,
(2)
ROE, = a, +aIBSIZE, +a,BOUT,+ a3DUAL,+ a4BINS,+ a5LEV,+a,SIZE,
+ a, AGE,+ E,
(3)
where EPS is net income divided by total shares; ROA is net income before extraordinary
items divided by the beginning balance of total assets; ROE is net income before
extraordinary items divided by the beginning balance of total equity; BSIZE is the number
of directors on the board; BOUT is the proportion of independent directors on the board;
DUAL is 1 if the CEO is also a board chair and 0 otherwise; BINS is 1 if there is a director
from institutional investors on the board and 0 otherwise; LEV is total debt divided by
total assets; SIZE is the natural logarithm of total assets; and AGE is the number of years
a given firm’s stock has been traded on the TSE.
4. Empirical Results
4.1 Descriptive statistics
Table 1 presents descriptive statistics about the variables. The average number of persons on the board of directors is 7.96, with about 22 percent of them being non-executive
managers or independent members. In 42 percent of the cases, the CEO is also the board
chair. In 46 percent of the cases, a representative from institutional investors is on the
board. The firms’ average size is 12.88, EPS is 1832 Rials’ ,ROA is 12 percent, and ROE
is 65 percent. Firms in Iran heavily rely on debt, with an average debt ratio of 60 percent,
which implies that their default risk is high. The average firm age for TSE listed companies
in our sample is 8.88 years.
Except for board size (BSIZE) and leverage ratio (LEV), all other variables have
medians larger than their corresponding means. This implies that the sample is slightly
skewed. The standard deviations of all the variables, however, are generally small except
for firm age. The fact that the regression analyses still generate significantresults suggests
that our findings are robust.
Table 2 shows the Pearson’s correlation for all variables used in this study. It is worth
noting that the three performance variables (EPS, ROA and ROE) are highly correlated.
Further, board independence (BOUT) is positively and significantly correlated with EPS,
ROA and ROE. This indicates that firms benefit from the presence of outside directors.
’ Iranian local currency, lRial is approximately equal to US$0.001064.
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Journal of Contemporary Accounting & Economics Vol4, N o 2 (December 2008) 156-172
164
Table 1
Descriptive Statistics
Acronym
Min
Median
Mean
Max
SD
Dependent Variable:
_______
~
Earnings per share
Return on assets
Return on equity
~~
EPS
ROA
ROE
~
396.00 2115.00
0.05
0.16
0.33
0.81
__________~
1832.00 3504.00
0.12
0.25
1.35
0.65
~
894.00
0.07
0.39
Independent Variable:
~~
~
Size of the board
Board independence
Board leadership (CEO-chair duality)
Institutional directors
~
BSIZE
BOUT
DUAL
BINS
5.00
0.09
0.00
0.00
6.90
0.26
0.55
0.49
7.96
0.22
0.42
0.46
10.00
0.40
1.00
1.00
1.68
0.12
0.50
0.50
3.00
11.59
0.45
10.30
14.10
0.57
8.88
12.88
0.60
27.00
16.04
0.85
8.46
1.40
0.12
Control Variable:
Firm age
Firm size
Leverage ratio
AGE
SIZE
LEV
EPS is earnings per share as measured by income divided by total shares; ROA is return on assets as measured
by income before extraordinary items divided by total assets; ROE is return on equity as measured by income
before extraordinary items divided by total equity; BSIZE is the number of directors on the board; BOUT is the
proportion of independent directors on the board; DUAL is an indicator of whether or not a firm’s CEO is also
the chair of the board of directors (DUAL is equal to 1 if the CEO is also the chair of the board and 0 otherwise);
BINS is an indicator on the existence of directors from institutional investors on the board (BINS is equal to 1
if there is a director taken from institutional investors on the board and 0 otherwise); AGE is the length of time
that the firm’s common stock has been traded on the T S E SIZE is the size of the firm as measured by a natural
logarithmic function of the firm’s total assets; and LEV is the total liabilities divided by total assets.
Board size (BSIZE) has negative and significant correlations with EPS, ROA and
ROE, indicating that larger board size generally reflects weaker controls and, therefore,
weaker performance. As for the correlation between board leadership (DUAL) and firm
performance, we find that board leadership is not associated with firm performance as
indicated by its statistically insignificant correlation coefficients with EPS, ROA and ROE.
An institutional director (BINS) is also not positively correlated with firm performance
(EPS, ROA and ROE) as expected.
The length of time that the firm’s common stock has been traded in TSE (AGE) is
not associated with firm performance, but the size of the firms (SIZE) is positively and
significantlycorrelated with firm performance. SIZE is positively and significantlycorrelated
with board leadership, but it is negatively and significantly correlated with AGE.
Table 2 also shows that leverage has negative correlations with firm performance, but
it has positive and significant correlations with board independence and board size.
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Journal of Contemporary Accounting & Economics VoC4,No 2 (December 2008) 156-172
Table 2
Correlation Matrix
EPS
EPS
ROA
1
ROA
ROE
BOUT
0.900
O.OOO**
0.888
O.OOO**
0.972
0.265
-0.422
0.003** O.OOO**
0.313
-0.499
0.001** 0.000**
0.285
-0.489
0.002** O.OOO**
1
0.832
I
O.OOO**
ROE
BOUT
BSIZE
DUAL
BINS
AGE
SIZE
1
DUAL
BINS
-0.045
0.627
0.013
0.892
0.053
0.563
-0.180
0.000** 0.049
1
-0.102
0.270
1
-0.120
0.193
-0.126
0.169
-0.069
0.455
-0.110
0.233
-0.137
0.134
0.635
BSIZE
AGE
-0.055
0.550
0.036
0.696
-0.026
0.778
-0.233
0.010*
-0.120
0.191
-0.355
0.000** O.OOO**
1
-0,147
0.108
1
SIZE
LEV
0.218
-0.299
0.016** O.OOO**
0.196
-0.307
0.031*
O.OOO**
0.193
-0.313
0.030*
0.001**
-0.035
0.515
0.706
O.OOO**
0.010
0.645
0.857
O.OOO**
0.001
0.217
0.010*
0.989
-0.141
-0.016
0.125
0.860
-0.318
-0.073
O.OOO** 0.426
1
-0.040
0.667
LEV
1
** and * indicate the significance level at the 0.01 and 0.05, respectively, based on two-tailed tests.
EPS is earnings per share as measured by income divided by total shares; ROA is return on assets as measured
by income before extraordinary items divided by total assets; ROE is return on equity as measured by income
before extraordinary items divided by total equity; BSIZE is the number of directors on the board, BOUT is the
proportion of independent directors on the board; DUAL is an indicator of whether or not a firm’s CEO is also
the chair of the board of directors (DUAL is equal to 1 if the CEO is also the chair of the board and 0 otherwise);
BINS is an indicator on the existence of directors from institutional investors on the board (BINS is equal to 1
if there is a director taken from institutional investors on the board and 0 otherwise); AGE is the length of time
that the firm’s common stock has been traded on the TSE; SIZE is the size of the firm as measured by a natural
logarithmic function of the firm’s total assets; and LEV is the total liabilities divided by total assets.
4.2 Regression results
Table 3 provides ordinary least squares (OLS) regression results for each of EPS, ROA
and ROE on the independent variables. These variables explain about 28 percent of the cross
sectional variation in EPS, 38 percent and 36 percent in ROA and ROE, respectively.
Consistent with H,, BSIZE is negatively correlated with EPS, ROA and ROE. This
indicates that small boards are associated with higher firm performance, possibly through
closely monitored management (Yermack, 1996; Eisenberg et al., 1998; Fuerst and Kang,
2000; Loderer and Peyer, 2002). This result is not similar to Dalton et al. (1998) who find
a positive and significant relationship between board size and financial performance.
Table 3 also shows that, as predicted by H,, the percentage of independent directors on
the board (BOUT), has a significant positive coefficient with the company’s profitability
(t-stat = 1.82 for EPS, t-stat = 3.23 for ROA and t-stat = 3.43 for ROE). These results
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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 156-172
166
Table 3
Cross Sectional Regression Test of Firm Performance (EPS, ROA and ROE) on Corporate Governance
Indices and Control Variables
EPS
Intercept
BOUT
BSIZE
DUAL
BINS
AGE
SIZE
LEV
R2
Adjusted R2
F
0.236
(2.23)**
0.29 1
(1.82)*
-0.698
(-4.14)***
-0.038
(-0.31)
-0.134
(-1.18)
-0.034
(-0.36)
0.218
(2.37)**
0.006
(0.06)
0.28
0.24
6.24***
ROA
0.577
(2.97)***
0.478
(3.23)***
-0.951
(-6.07)***
0.174
(1.52)
-0.268
(-2.54)**
0.123
(1.37)
0.195
(2.29)**
0.073
(0.75)
0.38
0.34
9.78***
ROE
1.236
(26 0 )**
0.515
(3.43)***
-0.955
(-6.01)***
0.171
(1.48)
-0.215
(-2.01)**
0.070
(0.77)
0.184
(2.13)**
0.047
(0.48)
0.36
0.32
9.14***
***, ** and * indicate the significance level at the 0.01,O.OS and 0.1, respectively, based on two-tailed tests.
EPS is earnings per share as measured by income divided by total shares; ROA is return on assets as measured
by income before extraordinary items divided by total assets; ROE is return on equity as measured by income
before extraordinary items divided by total equity; BSIZE is the number of directors on the board; BOUT is the
proportion of independent directors on the board; DUAL is an indicator of whether or not a firm’s CEO is also
the chair of the board of directors (DUAL is equal to 1 if the CEO is also the chair of the board and 0 otherwise);
BINS is an indicator on the existence of directors from institutional investors on the board (BINS is equal to 1
if there is a director taken from institutional investors on the board and 0 otherwise); AGE is the length of time
that the firm’s common stock has been traded on the TSE; SIZE is the size of the firm as measured by a natural
logarithmic function of the firm’s total assets; and LEV is the total liabilities divided by total assets.
suggest that agency theory’s theoretical predictions of a positive relationship between
outside (independent) directors and firm performance are also applicable in the Iranian
environment as well. This result is contrary to that of Yermack (1996) and Klein (1998)
who suggest that a high percentage of outside directors has the negative effect on firm
performance.
Contrary to H,, which predicts that separate individuals in the posts of CEO and board
chairman leads to a better corporate governance system and increased firm value, the
presence of duality in Iranian firms does not have a significant negative impact on firm
performance. This result is similar to that of Berg and Smith (1978), Chaganti and Mahajan
(1985), and Rechner and Dalton (1991).
Results suggest that the presence of institutional investors on the board (BINS) has a
negative impact on firm performance. This finding is contrary to that of McConnell and
Bita Mashayekhi and Mohammad S. Bazaz
167
Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 156-172
Servaes (1 990) and Krivogorsky (2006) who confirm that institutional investors’ impact
on firm valuation is generally positive. Based on this evidence, one may conclude that
corporate monitoring by institutional investors may not influence Iranian managers to
focus more on corporate performance. As explained earlier, both the Islamic faith and the
Revolution of 1979 have changed the culture of business in Iran. Corporate governance in
Iran is expected to optimize the interests of a broader group of stakeholders (i.e., suppliers,
employees, and the general community) rather than just maximizing the interests of shareholders. Allen (2005), finding similar results in some economically developed countries,
supported this interpretation by pointing out that “In countries such as Japan, Germany
and France, it is this broad view that is often stressed. Rather than shareholders alone, a
wider set of stakeholders, including employees and customers as well as shareholders, is
considered. In fact, in Germany the legal system is quite explicit that firms do not have a
sole duty to pursue the interests of shareholders” (p. 165).
Another possible interpretation of the negative relationship found between firm performance and the presence of board members from institutional investors can be traced to
corporate governance deficiency in Iran. This deficiency is more or less related to politicians
or to politically related business persons who seek incentives. For example, the Iranian
government has direct or indirect control over the majority of institutional investors. The
political and social factors specified above indicate that board members from institutional
investors are not primarily concerned about maximizing shareholder interests.
The test results also show that AGE is not associated with EPS, ROA or ROE, which is
inconsistent with the assumption that the longer a company survives in the capital markets
the more likely it is able to meet shareholders’earnings expectations (Krivogorsky,2006).
Similar to Gani and Jermias’ (2006) findings, the positive and significant coefficients on
SIZE (t-stat= 2.37 for EPS, t-stat= 2.29 for ROA and t-stat = 2.13 for ROE) indicate that
firm size has a positive impact on performance. Finally, the leverage ratio of the firm does
not have a statistically significant effect on firm valuation.
5. Conclusion
This study investigates the role of some corporate governance indices on a firm’s
performance in the emerging Iranian economy. We use board size, board independence,
board leadership and institutional investors on the board as corporate governance indices,
and EPS, ROA, and ROE as measures of firm performance. To test these hypotheses, we
use data from the TSE and information from annual reports of Iranian companies for the
2005-2006 financial years.
The findings of the present study support the contention that smaller boards are likely
to be more efficient in monitoring management (Yermack, 1996; Eisenberg et al, 1998;
Fuerst and Kang, 2000; Loderer and Peyer, 2002). This result contradicts that of Dalton et
al. (1998) who find a positive and significant relationship between board size and financial
performance. Our study confirms a positive relationship between outside (independent)
directors and firm performance, which is contrary to that of Yermack (1996) and Klein
(1998) who find that a high percentage of outside directors has a negative effect on firm
performance.
On the issue of duality,we find that its presence in Iranian firms has not had a significant
Bita Mashayekhi and Mohammad S. Bazaz
Journal of Contemporary Accounting & Economics Vol4,No 2 (December 2008) 156-172
168
negative impact on firm performance.This result is similar to that of Berg and Smith (1978),
Chaganti and Mahajan (1985), and Rechner and Dalton (199 1). While McConnell and Servaes (1 990) and Krivogorsky (2006) maintain that institutional investors’ impact on firm
valuation is generally positive, our research demonstrates that the presence of institutional
investors on the board (BINS) does not have a positive impact on firm performance.
In evaluating the results of this study, several limitations should be noted. First, Iran’s
strong Islamic culture and values could significantly affect our results. Therefore, generalizing the results to other institutional environments (especially non-Islamic) should be
viewed with caution. Second, our results are for the period studied (2005-2006) and should
not be extrapolated to different time periods, especially Iran today, because the authorities
have been trying to encourage foreign investment. Finally, it is plausible that corporate
governance variables that we have not considered could affect our results.
Appendix A
Summary of The Iranian Code of Corporate Governance
Chapter 1 (Descriptions)- Clause 1
This chapter offers descriptions and definitions, including those for independent manager, non-executive manager, minor shareholder,controlling,considerable dominance, stock
trustee, stock services, major shareholder, important/large companies, secret information
holders or insiders, mainlmother corporations, subsidiary corporations, affiliated corporations, dependent individual, subordinates and main managers.
Chapter 2 (Board of Directors) - Clause 2-20
This chapter describes the characteristic of the board of directors, such as structure
and duties of the board and the selection criteria and number of board members. The most
important issues are:
1. The directors’ qualifications and the effectiveness of the board;
2. Clear separation of responsibilities between directors on the board and
administrative managers;
3. Independence between the CEO and board chair;
4. Number and the composition of the board of directors;
5. The necessary presence of non-executive directors as the majority of the board
of directors;
6. The necessity of meeting at least once a month;
7. The necessity of the formation of the audit committee and delineating its responsibilities;
8. The necessity of having an effective internal control system for the safekeeping
of properties, appropriate reporting and observing the rules. The effectiveness of
the system is required to be evaluated annually.
Bita Mashayekhi and Mohammad S . Bazaz
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Journal of ContemporaryAccounting & Economics Val 4 , No 2 (December2008) 156-172
Appendix A (Cont.)
Chapter 3 (Public Assembly) - Clause 21-30
In this chapter the shareholders’ public society characteristics and responsibiIities are
discussed. Some of the important issues include:
1. Procedures for selecting the chairperson of the shareholders’ assembly meeting;
2. The way to determine compensation for each member of the board of directors;
3. The requirement of submitting board of directors’ reports and independent auditor’s report to the assembly meeting. These reports must be made public at least
ten days in advance of shareholders’ assembly’s meeting;
4. The necessity to publicly disclose/declare approved financial statements not more
than ten days after the public assembly meetings;
5 . The necessity of majority attendance by directors, independent auditor, legal warden
and that a representative from the stock exchange at public assembly meetings.
Chapter 4 (Accountability and Disclosure) -Clause 31 -36
In this chapter the following mandatory disclosures are discussed: annual financial
statements; six month interim financial statements; stock transaction information related to
the board of directors and top executive managers and their families; information related
to insiders; general information related to the organizational structure, products, human
resources, social responsibilities and company environment; and information related to
corporate governance, such as audit committees, the board of directors characteristics, and
the dividends paid by the company.
Chapter 5 (Frauds and Penalties) - Clause 37-38
This chapter covers manager and company fraud and penalties.
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