The Role Of Costs Management

Published Date: 02 Nov 2017

Abstract:

In this study the role of costs management is examined in company financial bankruptcy probability in consideration of corporate governance indexes. In the study the data from 68 companies listed in Tehran stock exchange were used during 6 months (From 2005 to 2010). Among the corporate governance features the possession concentration, the size of board of directors, the ratio of the unbound members of board of directors and the directing manager influence were examined. The study hypotheses were tested by regression method. The findings indicate that the companies with strong costs management are more powerful than ones with weak costs management. So it can be said that the ‘corporate governance indexes’ effect on financial bankruptcy probability’ is more in the companies with strong costs management than ones with weak costs management. So considering vital importance of identifying bankruptcy factors for each company and the importance of the study findings it can be said that first it is necessary to have a cost management system to establish appropriate corporate governance in the company.

Keywords: bankruptcy, agency theory, cost management, corporate governance.

1–INTRODUCTION:

In view of macroeconomics the economic development of a society is in line with the investment rate there; so if the investments are not in proper opportunities or used inefficiently, the state economics is damaged (Ross, 1995). Of most important subjects proposed in relation to financial management are investment and trust in investment. The investors are hopeful and sure their investment which is vital for social economic success would be kept and not be wasted when they are sure about their gains. The grantors and investors have great tendency to foresee the firms’ bankruptcy because they will sustain high costs, if the firms become bankrupt.

Having separated companies’ possession from their management the directors may take some decisions in line with their own benefits and against the shareholders’ (Jensen & Meckling, 1976); the benefits contradiction which is known as the ‘Agency Problem’ is due to two main factors: first the beneficiaries of each joint stock company have their special preferences and secondly no one has complete information about others’ knowledge and preferences (Berle & Means , 1932).

Recent great financial scandals in the companies such as Enron, Worldcom, Adelphi, crises increase, financial fines, etc. are in relation to the ‘Agency problem’; on this basis it is necessary to create supervision mechanisms in order to decrease the financial fines, improve the fiscal operation and finally prevent the companies’ bankruptcy; so when the mechanisms are executed the distance created between possession and control diminishes. One of such supervision mechanisms is to design and execute corporate governance system.

Since Berle & Means (1932) have proposed the hypothesis separating possession’s rights from the management’s and since Jensen and Meckling (1976) have examined the ‘Agency theory’ the method separating possession’s rights from the management’s has been vastly accepted by some modern companies; besides, because of some great frauds and also after financial crisis in Asia in 1997 the corporate governance structure became interesting in the World; thus, OECD (Organization for Economic Cooperation and Development) stated in 1998 that the corporate governance issue which has near relation with the management morals and honesty is the main factor preventing some Asian companies to develop (Kao and Yang, 2007). On the other hand, it seems necessary more and more the countries joining this universal contract pay attention to the costs management techniques considering increasing discussions concerning Universal Trading Organization so the techniques help them to be able to keep their economic durability in the competitive universal market and find appropriate potentials and readiness necessary to compete multilaterally.

In this study it is reasoned that there is a significant relation between the corporate governance and bankruptcy probability. Charito et al. state that the most usual cause for the company bankruptcy is the lack of internal control due to the weak companies’ dominance. So present study is essentially to find if there is any significant relation between the corporate governance and bankruptcy probability for the companies listed in Tehran stock exchange or if the costs management play any role in this relation.

2-LITERATURE REVIEW:

2–1: Corporate Governance:

One of the causes mentioned mostly in relation to company bankruptcy is lack of internal control originated from weak corporate governance. Because of separation of company from control and supervision discussion the shareholders are not able to deal with management discussion and the board of directors is obliged to secure the shareholders’ benefits. Thus, the board of directors formation and direction structure are important mechanisms supervising companies financial operation because they guide the directors to control internally in the corporate governance process (Darus and Mohamad, 2011).

Agency theory has been used vastly in the experimental studies issued in relation to board of directors and company operation discussion. Considering the separation of possession from control the shareholders are not able to interfere in management affair and the board of directors is obliged to protect shareholders’ benefits; however, there is no essential reason to believe that the directors do their best to secure shareholders’ benefits. If directors maximize their benefits in organization profitability costs, the shareholders’ benefits may face danger. In view of agency theory the directors are not trustworthy so monitoring (Supervision) mechanism is necessary to overcome probable differences between them (Darus and Mohamad, 2011).

We present some definitions concerning corporate governance as follows:

- The system by which companies are guided and controlled (Cadbury, 1992).

- Corporate governance means the supervision and control process to guarantee that the company director works in line with the shareholders’ benefits (Parkinson, 1994).

- The structures, processes, cultures or systems to provide successful organization operations(Cadbury, 1992).

2–2: Cost management:

Cost price is one of the important dimensions in competition; it is necessary to manage this factor in order to balance it with other competition dimensions namely quality and time; cost(Cost price) management one of the most important ones. The cost management system is to maximize company profit and value now and later. This goal is achieved when the cost management system is created so it leads to develop continuously and survive in world competition. The cost management system needs excellent management’s undertaking and belief in continuous improvement, client’s satisfactory, strategies programs to develop and benefit from worthy activities and elimination of valueless ones. Brinke (1998) states cost management as‘ The collection of techniques and ways to control and develop activities, processes, productions and related services ’ (Roodposhti, 2008).

Generally the cost management system is first to identify the cost price effect on the management decisions through assessing the sources used in doing the organization activities and secondly assess the effect of changing activities on the cost price; the cost price effect on the management’s decisions may be identified by devices and techniques; in other words, cost management means a collection of performances done by the management to satisfy the clients with continuous control and decrease of the costs (Cost price) (Roodposhti, 2008).

2–3: Bankruptcy:

In financial literature there no undistinguished word for bankruptcy; some of them are as follows: unfavorable financial situation, failure, firm failure, critical, bankruptcy, inability to pat debts, etc. Dun & Bradstreet (1998) defines bankrupt firms as follows: " The firms who stop their operations because of transferring, bankruptcy or stop current operations with loss by the creditors " (Roodposhti, 2008).

By virtue of Altman’s (1968) definition bankruptcy occurs when the company is not able to pay its debts so stop its commercial operations. There are different definitions for bankruptcy. In one of his studies concerning financial inability theory Gordon (1971) defines it as the company’s profitability power decrease which increases inability probability to repay the interest and main debt. It is not easy to define the accurate cause(s) for bankruptcy and financial problems. In most cases several causes together lead to bankruptcy. Dun & Bradstreet (1998) state financial and economic problems as main cause for bankruptcy (Roodposhti, 2008).

3– THE STUDY HISTORY:

Simpson & Gleason (1999) examined the relation between corporate governance features and bankruptcy. Their findings showed that the managing director’s influence decreases the financial crisis occurrence probability in next five years, but other corporate governance features have no considerable effect on the financial crisis occurrence probability and bankruptcy. They concluded that the managing director’s influence has effect on the internal control system of the company to prevent financial disorder and bankruptcy occurrence and this conclusion indicating a strong manager decreases crisis probability and financial disorder is in harmonization with previous theory and experimental evidences.

Elloumi and Gueyie (2001) proved there is a significant relation between the independence of directors’ board financial risk conditions. They concluded that the companies who faced financial risks had less unbound members in their directors’ board. Byrd et al. (2001) stated that the companies’ rescue from financial risk depends on the stability and independence rate of their members of directors’ board.

Jostarndt & Sautner (2008) examined the relation of company control and possession structure with financial risk. Their findings indicated the companies who faced financial crisis had less possession concentration; their conclusion was not in accord with Simpson & Gleason (1999). The later found that the companies who faced financial crisis had more possession concentration.

Darus and Mohamad (2011) examined the corporate governance and failure in view of agency theory. Their findings indicated that there is a considerable negative relation between the managing director’s influence and financial risk conditions indicating the managing director’s influence as a factor functioning in the best way, creating better strategic view and decreasing agency problems. Also the findings showed that other corporate governance variables considered in the study such as the percent of unbound directors, management possession, familial possession, internal auditing independence, internal auditing proficiency and internal control mechanisms have no significant relation with company financial risk conditions. The dependent variable considered in the study was bankruptcy risk. Their findings indicated there is a reverse and significant relation between the managing director’s influence and financial risk conditions and stated that the financial risk occurrence probability is less in the companies with high managing director’s influence.

Chen & Al-Najjar (2012) examined the effect of other corporate governance features on the size and independence of directors’ board in Chinese companies; their findings showed there is a significant and negative relation between the ratio and size of unbound members in directors’ board, possession concentration and independence of the board. Also there is a significant and positive relation between the size of directors’ board and company size.

Lakshan & Wijekoon (2012) examined the effect of corporate governance features of Sri Lankan companies’ failure. Their findings indicated that there is a significant and negative relation between unbound directors’ ratio and bankruptcy risk. The directional structure was different in two samples of the companies in a way that the managing director’s influence was more in the bankrupt companies than in the non-bankrupt (Solvent) ones. So there is a significant and positive relation between the managing director’s influence and bankruptcy risk. They found a significant and negative relation between the directors’ board size and bankruptcy risk and no significant relation between the independent variable: outer possession and bankruptcy risk. Finally they believed that a weak corporate governance may increase the bankruptcy probability even in the companies with good financial operation and the study findings show some view regarding the corporate governance role in the companies’ financial health. In their study Platt et al. (2012) examined the role and features of directors’ board and their composition way in relation to the company success and ability to pay debts. Their findings indicated that both arrangement and features of directors’ board influence the company bankruptcy.

4– HYPOTHESES DEVELOPMENT:

The cost management is a mechanism to indentify the changes in the production methods and sale and its effects on the costs structure and provide the data in relation to the costs. Nowadays the costs management execution with continuous improvement is considered as one of the vital elements for organizations’ success.

The information resulted from cost management help the director to assess and measure the function. The financial and nonfinancial scales in the costs management system are usable for different goals in different levels of the organization. The data provided by the costs management system permit the directors to analyze strategically the problems such as organization competition situation, assessing positive and negative financial and nonfinancial investment factors and operational plans to benefit from the personnel potentials to achieve the management goals (Banfield, 1998).

The costs management system include a collection of the methods defined to program and control the costly activities for the organization in order to achieve the organization goals; the system is to program and control and examines the operation optimization (Ghanbari, 2007).

By virtue of h relation and effect of the system with other ones in the organization Berisam (1988) believes in at least six goals for it: presenting relatively accurately the cost price for the products and services, assessing life cycle of the products and services, improving and promoting the conception concerning the processes and activities, cost control and operation assessment and following organizational strategies. It goes without saying that it is not necessary to present accurate and completely proper information in the system, but it is enough to cover the benefits increase limits beyond costs. The best system is one who present relatively accurate data to help the company in line with activity in the competitive environment (Cooper and Kaplan, 1999).

Kaplan & Norton (2004) have attributed the cost management to the function management in four dimensions: financial, client, internal processes and training and growth). One of the important features of their model is the presentation of the function size defined by the some beneficiaries such as personnel, grantors, partners, clients, shareholders, government d generally the community). Besides, Kaplan & Norton (2004) have formed a cause and effect architecture by relating the four dimensions where the strategic map is drawn to a direction making the organization clarify the logic creating value and persons waiting for value creation (Roodposhti et al, 2011).

By virtue of above subjects the study is to examine the special effect of cost management which is considered as one of the vital and main factors for companies’ success on the corporate governance mechanisms and bankruptcy probability so the hypothesis is as follows:

H1: The cost management influences the relation between corporate governance indexes and company financial bankruptcy probability.

5– STUDY METHOD:

The model to be used in the study is as follows:

FED: Bankruptcy probability.

Sizeown: Directors’ board size.

Bind: The ratio of unbound members in the directors’ board.

CEO Influence: Managing director’s influence (The head of directors’ board is bound member).

Conc: The possession concentration percent.

LEV: Financial leverage.

ROA: Asset gain.

The method to measure the study variables is shown in Table 1.

Table 1: Study variables and method to measure them

variable

measurement method

The bankruptcy risk

The bankruptcy risk is measured by logit model. The result which is between zero and ‘1’, if it is closer to ‘1’, the bankruptcy risk is higher

The ratio unbound members

The unbound members is measured as the unbound members’ share in directors’ board ratio to total directors’ board members.

The managing director’s influence

If the head of directors’ board is an unbound member, the managing director’s influence is ‘1’ and if the head of directors’ board is a bound member, the managing director’s influence is ‘0’

The directors’ board size

The directors’ board size is total directors’ board members

possession concentration

The possession concentration is measured by Herfindal–Herishman index which is equal to square 2 of total shares available to five main shareholders

Financial leverage

Financial leverage is measured as total debt percent to total asset

ROA

ROA is the income before tax divided by total asset

Cost management

Cost management is gained by the operational profit percent ratio to gross profit

Firm size

Firm size is measured on the basis of firm sale logarithm

6– DATA ANALYSIS:

Study descriptive statistics:

The descriptive statistics of the study variables are shown in Table 2:

Table 2: The descriptive statistics

Variables

Mean

Std

Min

Max

FD

0.1501

0.15089

0.00

0.73

Sizeown

5.2868

0.77973

4

0.8

Bind

0.6489

0.19976

0.20

1

CEO Influence

0.6667

0.66626

0.00

10

Conc

0.2266

0.23919

0.00

1

LEV

0.6370

0.21595

0.13

0.99

ROA

0.1288

0.15313

-0.32

0.65

The correlation matrix of the study variables.

Table 3: Study variables correlation in the companies with strong and weak costs management.

Conc

CEO

Bind

SizeOwn

ROA

LEV

FD

Correlation Probability

1

correlation

FD

Companies with strong cost management

-

significance

1

0.450679

correlation

LEV

-

0.0000

significance

1

-0.549106

-0.713091

correlation

ROA

-

0.0000

0.0000

significance

1

-0.450901

0.069243

0.425318

correlation

SizeOwn

-

0.0000

0.3251

0.0000

significance

1

0.187293

-0.236073

0.109266

0.385999

correlation

Bind

-

0.0073

0.0007

0.1198

0.0000

significance

1

-0.082785

-0.229484

0.395131

-0.261880

-0.446843

correlation

CEO

-

0.2391

0.0010

0.0000

0.0002

0.0000

significance

1

0.265625

-0.110404

-0.415496

0.570886

-0.347413

-0.332752

correlation

Conc

-

0.0001

0.1159

0.0000

0.0000

0.0000

0.0000

significance

1

correlation

FD

Companies with weak cost management

-

significance

1

0.338022

correlation

LEV

-

0.0000

significance

1

-0.540787

-0.576318

correlation

ROA

-

0.0000

0.0000

significance

1

-0.234404

0.139667

0.498230

correlation

SizeOwn

-

0.0007

0.0463

0.0000

significance

1

0.291017

-0.203047

0.166275

0.411723

correlation

Bind

-

0.0000

0.0036

0.0175

0.0000

significance

1

-0.208271

-0.170606

0.257172

-0.183315

-0.360742

correlation

CEO

-

0.0028

0.0147

0.0002

0.0087

0.0000

significance

1

0.080606

-0.240674

-0.325464

0.121952

-0.043721

-0.288149

correlation

Conc

-

0.2518

0.0005

0.0000

0.0823

0.5347

0.0000

significance

As it can be seen in the column ‘FD’, Table 3 the study variables significance is less than 0.05 so there is correlation between above variables and the company bankruptcy probability in both models. Also as you see in the Table the variables: financial leverage, the size of board of directors and unbound members ratio of the board have significant direct relation bankruptcy probability and the assets return, managing director’s influence and ownership concentration percent have significant and reverse relation with bankruptcy probability.

Study hypotheses test:

The test was done in two following subgroups: the companies with strong and weak cost management presented later.

Table 4: hypothesis test in the companies with strong and weak cost management

test

variables

variables coefficients

significance level

Companies with strong cost management

test ‘t’

the width from origin

0

.5206

financial leverage

.074

.0215

ROA

-.447

0

directors’ board size

.023

.0034

the unbound members ratio

.136

0

managing director’s influence

-.049

.0001

possession concentration

-.076

.0049

test ‘F’

definition coefficient

Durbin– Watson

0

.622

1.997

Companies with weak cost management

test ‘t’

the width from origin

-.177

.0182

financial leverage

.18

.0009

ROA

-.538

0

directors’ board size

.061

0

the unbound members ratio

.152

.0004

managing director’s influence

-.032

.0022

possession concentration

-.063

.0022

test ‘F’

definition coefficient

Durbin– Watson

0

0.545

1.926

The significance rate is less than 0.05 for both models so both models are significant. By virtue of the data presented in Table 4 the regression coefficients are significant and final study model is done in two subgroups: companies with strong and weak cost management as follows:

FD = 0.023Sizeown + 0.136Bind -0.049CEO – 0.076Conc +0.074LEV –0.447 ROA

Also by virtue of the data presented in Table 4 the regression coefficients are significant and final study model equation is done in companies with strong and weak cost management as follows:

FD = 0.061Sizeown + 0.152Bind -0.032CEO – 0.063Conc +0.18LEV –0.538ROA-0.177

By virtue of the data presented in Table 4 the study models were proved so the models are accurate and effective enough in the level of all companies.

Vuong Test:

It was proposed to compare the model potency in both proposed subgroups.

Table 5: Vuong test

subgroup

R-Square

p-value

Model, in the companies with strong cost management

0.622

0.0006

Model in the companies with weak cost management

0.545

Considering the significance measured in above Table is less than 0.05 the difference between models definition coefficients is significant and as you see the potency of the companies with strong cost management is more than ones with weak cost management.

7– CONCLUSION:

The findings indicate there is a reverse and significant relation between possession concentration and bankruptcy probability. Thus, the findings indicate that if possession concentration increases, the shareholders power to supervise the management increases, too so the bankruptcy probability decreases. On the basis of done studies possession concentration increases the supervision on management (Peasnell et al., 2000); hence, the study findings are in accord with others’ such as Charitou et al. (2007) and Jostarndt and Sautner(2008).

The findings indicate there is a direct and significant relation between directors’ board and bankruptcy probability. Thus, the findings show that if directors’ board size increases, its efficiency to supervise management decreases and then bankruptcy probability increases.

The study findings is not in accord with the findings of Lakshan and Wijekoon (2012) and Platt et al. (2012) indicating there is a negative and significant relation between directors’ board size and bankruptcy probability, but the study findings are in accord with Simpson’s and Gleason’s (1999).

The findings indicate there is a direct and significant relation between directors’ board unbound members and bankruptcy probability. So the findings indicate if directors’ board unbound members increase, the directors’ board has not necessary efficiency ; probably the supervision on management decreases and bankruptcy probability increases. It seems there are some other probable reasons for above hypothesis result such as simultaneous membership of unbound members in several directors’ board of several companies decreasing their efficiency. Darus’ and Mohamad’s (2011) study findings are in accord with Platt’s et al. (2012).

The findings indicate there is a reverse and significant relation between managing director’s influence and bankruptcy probability. Thus, if managing director’s influence increases, he (she) has more power and takes better decisions led to function improvement so the bankruptcy probability decreases. The findings gained in this study are in accord with Simpson’s and Gleason’s (1999) and Darus’ and Mohamad’s (2011) who found that the managing director’s influence decreases the company confrontation with financial crisis.

As you see the independent variables: directors’ board size and directors’ board unbound members ratio have significant and direct relation with company bankruptcy probability and also the independent variables: possession concentration and managing director’s influence have reverse and significant relation with the dependent variable: company bankruptcy probability.

On the other hand, by virtue of the Vuong Test findings proposed to examine and compare the model potency in the two subgroups based on cost management and according to the hypotheses test based on the grouping in two levels: companies with strong and weak cost management it is very clear that the effect of ‘ Corporate governance indexes on bankruptcy probability ’ is more in the companies with strong management than in the companies with weak cost management. So considering it is vital to identify the bankruptcy factors in every company and by virtue of this study findings it can be said that first it is necessary to establish a cost management system in the company in order to have an appropriate corporate governance to decrease bankruptcy probability and as the general conclusion it can be said that applying each cost management technique and paying attention to corporate governance indexes are effective to improve the company function and long–term company survival and finally prevent financial crisis and company bankruptcy phenomenon.