Corporate Governance In The Global Context

Published Date: 02 Nov 2017

1

Yudi Limenta Soejanto

F2656962K

Table of Contents

Table of Contents 2

Context/Background    3

Summary of Literature Review 4

Corporate Governance in the Global Context 4

Corporate Governance in the Singapore context 4

Importance of SMEs 5

Challenges in implementing Corporate Governance in SMEs 5

Research Gaps of Corporate Governance in SMEs 6

Research Questions and Hypotheses 7

Summary of Research Methodology 10

Preparation stage 10

Data Collection stage 10

Analysis and Reflection stage 13

Report writing stage 14

Ethics and Safety requirements explained 15

Limitations 16

List of references 17

Appendix A Research Timetable 19

Context/Background   

In Singapore, 99% of all enterprises today are Small and Medium Enterprises (SMEs) which employ 7 out of every 10 workers and their contributions exceed half of our national GDP (SPRING Singapore, 2012). [1] 

Indeed, SMEs are essential to the economic development of countries in many parts of the world, and particularly so in emerging countries as they create mass employment opportunities and contribute towards the Gross Domestic Product (GDP) of the countries they operate in (Rachagan and Satkunasingam, 2009).

Being a cornerstone in the economy, it is thus important to ensure the corporate governance systems are working effectively in these SMEs to maintain the sustainability and growth of these firms.

Good corporate governance practices enable SMEs to establish robust business processes and position them better to capitalize on future expansion opportunities because corporate governance systems make SMEs more accountable and transparent in their business operations which would help to attract more capital investment from banks and equity investors (Dubai SME, 2011). Yet, the lack of proper corporate governance mechanisms has been widespread in many countries such as Ghana where corporate governance at the SMEs level is barely existent (Business and Financial Times, 2009).

Moreover, SMEs face other types of corporate governance issues which include improper accounting methods, lacking the upkeep of annual statements of accounts and a proper internal control system (Dubai SME, 2011). Although having the same people as shareholders and managers may better align interests and mitigate agency conflicts, there would be no external independent directors on their boards to inject new strategic perspectives to enhance the SMEs’ corporate entrepreneurship and competitiveness (Business and Financial Times, 2009).

Given the importance of corporate governance in improving transparency, accountability and competitiveness of the SMEs, it warrants a research study to develop a model to assess the quality of corporate governance among Small and Medium Enterprises (SMEs) in Singapore.

Summary of Literature Review

Corporate Governance in the Global Context

Corporate governance refers to the set of systems, principles and processes by which a corporation is governed and they guide the way a corporation is directed or controlled such that its goals and objectives could be fulfilled to benefit all the stakeholders in the long run (Thomson, 2009).

According to a report published by the Organization for Economic Co-operation and Development (OECD), the corporate governance model serves to promote transparent and efficient markets, comply with the legal rules and expressly details the division of responsibilities among different supervisory, regulatory and enforcement agencies (OECD, 2004).

As entrepreneurial firms grow, there is an even greater need for a comprehensive corporate governance model to address the agency issue stemming from the separation of control and ownership. Accounting controls and internal audits would be required to help in the assessment of management’s performance while the inclusion of external directors on the board would help to overcome managerial incompetence by offering their expertise apart from becoming effective independent monitors to safeguard minority’s interests (Business and Financial Times, 2009).

Corporate Governance in the Singapore context

Although Singapore is internationally recognized for its good corporate governance, which won Singapore the Asia’s best corporate governance title for a number of surveys, including the CG Watch 2005, Singapore corporate governance standards still lag behind developed economies such as Australia, United Kingdom and United States of America (Mak, 2007). By tightening the corporate governance standards in Singapore, it would inevitably improve Singapore’s reputation as an international financial hub, enhance the liquidity of the equity markets, lower the cost of capital and increase its attractiveness for international investment for the firms in Singapore (Mak, 2007). It is therefore imperative to upload the highest standards of corporate governance for both large enterprises and SMEs.

Importance of SMEs

The World Bank Group is committed to the development of SME sector as a central element in its strategy to foster economic growth, raise employment levels and alleviate poverty. Increasingly recognized as a key player in sustained global and regional economic recovery, the World Bank Group has disbursed approximately $2.8 billion to support the growth of the SME sector (Ayyagari, Beck and Demirgüç-Kunt, 2005).

Indeed, the SME sector is increasingly associated with being a major source of entrepreneurial skills, innovation and employment. In the European Union which consists of 25 countries, 99% of all the enterprises are represented by 23 million SMEs that provide almost 75 million jobs (European Commission, 2005).

Despite all the benefits SMEs provide, they often meet market imperfections where obtaining capital or credit is fraught with difficulties, especially in the early start-up phase. SMEs also face the problem of restricted resources that may also reduce their access to new innovation and technologies that in turn stunt their growth and development (European Commission, 2005).

Possessing stronger corporate governance mechanisms may not certainly lift the hurdle in raising capital or credit to fund their growth, but it would put them in a more favorable position in attracting investors.

Challenges in implementing Corporate Governance in SMEs

Some have argued that there is no need for the implementation of corporate governance mechanisms in SMEs as there is usually no separation of ownership from control, leading to the managers being both intrinsically and extrinsically motivated to maximize profits and accountability is dispensable since there is no public interest (Business and Financial Times, 2009). This argument is particularly strong for family owned SMEs which are the most common form of business organization and they play a pivotal role in modern economics (Madueñoa, Jorgeb and Gardey, 2011). For the purpose of this study, family business is defined to be a business controlled and managed by the members of a single family (Daily and Dolliger, 1991). The opposition to implementation of corporate governance mechanisms is further supported by an empirical study that shows family ownership and management having a positive influence on financial and operational performance, greater cost efficiency and return on investments as compared to non-family firms (Lee, 2004). Therefore, this phenomenon would continue to pose a challenge to the implementation of corporate governance in SMEs.

On the other hand, others have argued that similar corporate governance guidelines which apply to publicly listed firms should be applicable to SMEs too as corporate governance could infuse better management practices, more stringent internal auditing or control procedures and position the firm well to capitalize on growth opportunities (Business and Financial Times, 2009).

Furthermore, the adoption of good corporate governance practices helps to prepare the SMEs for their initial public offerings since it weakens the association with information asymmetry, thus investors would perceive such investments as less risky and value them higher (Business and Financial Times, 2009).

Nonetheless, achieving the smooth transition from a SME to a large publicly listed company with the use of an effective corporate governance system is not without cost. Maintaining an internal audit team and hiring of independent directors entail higher operational costs which should be outweighed by the benefits an effective corporate governance system could provide (Business and Financial Times, 2009).

Research Gaps of Corporate Governance in SMEs

Most existing studies conduct corporate governance research on large companies which could explain why studies that explicitly investigate the effects of corporate governance on the corporate performance of SMEs are rare (Madueñoa, Jorgeb and Gardey, 2011).

Therefore, this research serves to supplement to the literature of corporate governance in SMEs by compiling and improving on the scarce SME corporate governance data currently available.

Moreover, most academic papers have discussed about various theories on the topic of corporate governance but do not provide a systematic approach in analyzing these theories deeper so as to provide a clear relationship between corporate governance measures and corporate performance.

As for academic papers that demonstrated the linkage between corporate governance measures and corporate performance, the empirical evidence till present is mixed and therefore provides minimal support for an optimal corporate governance model (Core, Holthausen and Larcker, 1999).

Consequently, this research aims to identify the core corporate governance measures that are related to firm performance so as to formulate a comprehensive corporate governance model that would be useful to the firm managers and investors in improving corporate performance.

Research Questions and Hypotheses

For the purpose of this study, SMEs studied would only include incorporated companies and corporate performance would be measured by financial performance, market performance and management efficiency. The 5 research questions for this study are:

RQ1: Which corporate governance measures are correlated to financial performance?

(H1 and H1a to H1d)

RQ2: Which corporate governance measures are correlated to market performance?

(H2 and H2a to H2d)

RQ3: Which corporate governance measures are correlated to management efficiency?

(H3 and H3a to H3d)

RQ4: Does the industry in which the firm is situated in have any moderating effect on the relationship between the corporate governance and corporate performance?

RQ5: Does the size of the firm moderates the relationship between the corporate governance and corporate performance?

The hypotheses are tested as follow:

H1: Corporate governance measures are positively correlated to the financial performance.

H1a: Number of independent directors is positively related to financial performance.

H1b: Separation of ownership and control is negatively related to financial performance.

H1c: Presence of internal control/audit system is positively related to financial performance.

H1d: External audit quality is positively related to financial performance.

H2: Corporate governance measures are positively correlated to the market performance.

H2a: Number of independent directors is positively related to market performance.

H2b: Separation of ownership and control is negatively related to market performance.

H2c: Presence of internal control/audit system is positively related to market performance.

H2d: External audit quality is positively related to market performance.

H3: Corporate governance measures are positively correlated to the management efficiency.

H3a: Number of independent directors is positively related to management efficiency.

H3b: Separation of ownership and control is negatively related to management efficiency.

H3c: Presence of internal control/audit system is positively related to management efficiency.

H3d: External audit quality is positively related to management efficiency.

The above hypotheses will be tested a total of 3 times as follow:

Process all information to answer RQ 1 to RQ 5.

Separate the respondents according to their industry and process the information separately.

The results are compared and contrasted according to industry for RQ 4.

Separate the respondents according to their firm size and process the information separately.

The results are compared and contrasted according to firm size and for RQ 5.

Summary of Research Methodology

There are a total of four stages in this research study (Palsson, 2007), specifically:

Preparation stage

The first stage is typically characterized by the execution of administrative work which includes finding a supervisor and submitting an ethics application. While waiting for the approval of the ethics committee, questionnaires regarding corporate governance and corporate performance of the SMEs would be drafted. The questionnaire will be used to query about the various corporate governance measures of a SME and their quantitative performance measures. It is necessary to use this method as the amount of information available about company specific corporate governance is limited for SMEs.

In order to increase the response rate of the surveys, there would be social calls to SMESs to establish amiable relationship. It is imperative for researchers to build up understanding and trust with the respondents to be studied so as to increase the success rate of the research study (Hammersley and Atkinson, 1995).

Subsequent to the approval of the ethnic application approval, I will send the letters asking for the permission to conduct the research study to those SMEs who have expressed keen interest during the social reach outs. SMEs which are experiencing financial or operational difficulties may be more willing to take part in the research as the results may shed light on the possible improvements that could be undertaken by them.

At the same time, more research work could be carried out together with the literature review.

Data Collection stage

After obtaining the approval and support from the SMEs, questionnaires regarding the corporate governance and corporate performance will be sent to the SMEs. Participation is voluntary and consent is acknowledged when the questionnaires are returned. To prevent any withdrawal, SMEs will be notified on the cover letter that withdrawal is not permissible. To increase the motivation, it should be stated that the survey results will be provided.

Given the large number of SMEs in Singapore, this survey will be carried out by emailing (SPRING Singapore, 2012). The number of emails to be sent out will be large to ensure sufficient returns. Participants will be drawn from different industries at various firm sizes to ensure that there is a good representation of the SME population to validate the use of the corporate governance model customized for the SMEs in general. Therefore, questionnaires will be sent to all the SMEs that are within the scope of this study, namely the incorporated companies because under S175, S195 and S201 of the Companies Act, it is necessary for all locally incorporated companies to conduct their Annual General Meeting and file their annual returns (Accounting and Corporate Regulatory Authority, 2012).

Therefore, for unrepresented industries with no response, SMEs’ information could be obtained from various sources such as the company website or Accounting and Corporate Regulatory Authority (ACRA) which allow the extraction of accurate accounting records and up to date corporate governance data like the corporate and management profiles.

There are many factors that may affect the state and quality of corporate governance in small and medium enterprises. However, it will be limited to the case of the following independent variables in the left-most table and it will be studied with the following dependent variables in the middle table.

Theoretical Framework

Factors determining state and quality of corporate governance in a firm

Corporate performance metrics

Corporate governance model

1. Number of independent directors on board

2. Separation of ownership and control

3. Internal control/audit system

4. External audit quality

5. Size of the firm

6. Industry that the firm is operating in

1. Financial performance

(e.g. ROA, ROE, Profit margin, Earnings per share, revenue growth rates)

2.Market performance

(e.g. Receivables collection period, payables payment period, inventory holding period)

3. Management efficiency

(e.g. market share in new markets or existing markets, customer satisfaction level)

Relationships between the independent variables and dependent variables that are statistically significant will be weighted and incorporated into the corporate governance model for application to SMEs.

However, before the questionnaires are disseminated to the respondents, it is advisable to test for content validity. 3 specialists in the corporate governance field will be invited to critique the questionnaire to ensure the questions sufficiently represent the construct. As long as a question is judged by the majority of the specialists (e.g. 2 out of the 3 specialists) to be weakly representing the construct, it will be taken out of the questionnaire. Only questions that show the strong representation of the construct will be kept in the final questionnaire.

To ease the evaluation process, all the 3 specialists will be each given a feedback form to rate each question where there will be 2 options "Strong" and "Weak" to select from. There will also be lines under the heading "Possible improvements" for each question.

Analysis and Reflection stage

Analysis of data is a crucial stage where researchers study the information very carefully to identify and construct relationships or patterns in areas like time, social context, personnel and respondent validation (Siew, 2008e).

Therefore based on the data collected, an analysis would be done to see which of the corporate governance factors contributes most to the company’s performance for firms in various sizes and industry in the SME category. With this analysis, it would be possible to rank the factors of corporate governance that in order of importance to the performance of SMEs.

However, the initial step is to ensure that there is a purification of the data through the computation of Cronbach’s coefficient alpha (Parasuraman, 1988). In the event that Cronbach’s alpha is below 0.7, some of the questions are to be removed so as to increase the Cronbach’s alpha.

The next step is to conduct the Exploratory Factor Analysis (EFA) as recommended by (Hair, 1998). In this data analysis, it should satisfy the three tests of assumptions:

KMO measure of sampling adequacy is used to determine whether the sample is appropriate to run EFA and must reach at least 0.6 and above to be sufficient.

Bartlett’s test of sphericity is used to check if there is any pairwise correlation among the variables.

Ratio of observations to independent variables should not fall below 5 (Bartlett et al., 2001).

The third step is to produce tables of descriptive statistics which will typically comprise of the mean expectation, perception and gaps for all the questions; sum of expectations and perception scores for individual question. Bar charts should present the firm size and industry distributions.

Fourthly, multivariate regression tests will be carried out to evaluate and establish the strength and direction of the relationships between the 3 dependent variables (financial performance, market performance, management efficiency) and the independent variables (number of independent directors on board, separation of ownership and control, internal control/audit system, external audit quality), with control variables as the moderating factors (size of the firm, industry that the firm is operating in). This could be done by first analyzing the significance of F where the null hypothesis is all of the regression coefficients are zero. If the null hypothesis is rejected, and the p value of the t test is less than the 5% level of significance, this indicates a significant result and the coefficient is deemed to be significantly different from zero.

Last but not least, a model would be constructed to assess the quality of corporate governance in the SME sector by giving differing weights to the various factors depending on their significance on the different corporate performance metrics as analyzed from above. With this model, it would then be possible to assess the quality of corporate governance in SMEs in Singapore.

Report writing stage

At this stage, all the research information and analyses will be compiled to add to the pool of existing corporate governance literature.

The four stages in this research study are detailed in the timetable as attached in Appendix A (Research Timetable).

Ethics and Safety requirements explained

In this study, the surveys will be emailed to the SMEs as there are substantially huge number of enterprises, thus it will not be cost efficient to send by post. Participation in the survey will be on a voluntary basis and consent to the disclosure of information will be implied when the questionnaires are emailed back. To prevent any withdrawal from the questionnaires, SMEs will be notified on the cover letter of the questionnaires that withdrawal from the survey is not permissible. However, to allay fears of the confidentiality issues, SMEs will be informed that the survey is conducted on an anonymous basis.

However, high non-response rates of surveys remain an issue according to a study that has covered more than 100,000 organization respondents, where the average response rate was 35.7% with a standard deviation of 18.8% (Baruch and Holtom, 2008). Therefore, in order to boost the response rates, some hold the perceptions that compensation should be provided for the time spent by the SMEs to complete the surveys so as to increase their motivation to do the questionnaires.

However, according to some academics, such compensation should not be extrinsic rewards that may cause respondents to go beyond the ethical line to solely provide information for the sake of monetary awards (Marshall and Rossman, 2006). Instead, intrinsic rewards should be offered where it should be stated that the results of the survey will be given to them for self-assessment in benchmarking themselves against the optimal model of corporate governance.

Finally, information for this study is publicly available through ACRA, albeit at a cost, and no field work is conducted since only email survey is involved, there is no safety requirement concern.

Limitations

Although the study outlines a comprehensive corporate governance model that could be indicative of a firm success, it must be cautioned that good governance does not guarantee business success. Nevertheless, poor governance could signal potential business failure (Business and Financial Times, 2009).

Moreover, the mail survey has been criticized for non response bias and thus, being constrained by the number of valid and returned responses may make generalization of the sample results to the population harder (Armstrong and Overton, 1977).

As this study only focuses on incorporated companies, the model may not be applicable to other business forms of SMEs which are namely the sole proprietorships and partnerships.

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