Corporate governance, ownership structure and the performance of South African firms: impact of the global financial crisis.

Transcription

1 oikos PRI Young Scholars Academy 2011: The Future of Responsible Investment Corporate governance, ownership structure and the performance of South African firms: impact of the global financial crisis. This is a work in progress. Please do not cite without permission of the author. Nadia Mans nadiamans@sun.ac.za Room 301 Schumann building Private Bag X1 Stellenbosch University Matieland 7601 Abstract Responsible Investing (RI) can generally be defined as the integration of environmental, social and corporate governance (ESG) considerations into investment management processes and ownership practices in the belief that the factors can have an impact on financial performance (UNEP FI, 2007). Given that South Africa is an emerging market, limited data are yet available on how listed firms are managing ESG risks, especially with regard to social and environmental data. However, it appears that since the publication of the King Report II in 2002, most Johannesburg Securities Exchange (JSE) listed firms have improved their reporting on corporate governance information. The focus of this study is consequently on corporate governance and its relationship with firm performance and ownership structure. While prior studies mainly focused on a specific performance measure such as profitability, this study will consider various measures of firm performance including accounting-based, market-based, cash flow as well as value-based measures. The King Reports indicated that the board of directors should be the centre point of corporate governance within South Africa. Therefore, board specific measures of corporate governance will be used in this study. Prior studies indicated that ownership structure has relations with firm performance and corporate governance. Therefore, ownership structure will also be included in this study. The global financial crisis of 2007 offers an alternative setting for evaluating the relationship between corporate governance, ownership structure and firm performance within the South African context.

2 1. Introduction There are three steps in the revelation of any truth: in the first it is ridiculed; in the second, resisted; in the third it is considered self-evident. This claim by the German philosopher Arthur Schopenhauer ( ) is especially appropriate in the light of increasing calls from a new generation of investors to integrate environmental, social and corporate governance (ESG) considerations into investment analysis and ownership practices (Viviers, Bosch, Smit and Buijs, 2009: 3). This phenomenon has several names, but for the purpose of this research, reference will be made to Responsible Investing (RI). According to the United Nations Environment Programme Finance Initiative (UNEP FI) (2007) the market for RI products is growing internationally as increasing numbers of investors are recognising the impact of ESG risk management on financial performance. In a report on corporate sustainability disclosure in emerging markets it was indicated that few countries offer comprehensive ESG reporting (Social Investment Forum, 2009). The results were based on ESG data reported by the top ten firms of ten emerging markets, ranked in terms of market capitalisation. South Africa was noted as an exception. Firms based in South Africa exhibited the best overall transparency practices, reporting some form of ESG data. The highest reporting rate was for issues relating to corporate governance. Of the three ESG categories, environmental data were the least likely to be reported. A possible reason for the higher levels of corporate governance reporting could relate to the regulatory and listing requirements set by governments and stock exchanges in the observed countries. The Social Investment Forum report suggested that, although reporting is widespread in emerging markets, it is often limited in depth. Although firms in South Africa are better at reporting on corporate governance issues than their counterparts in other emerging countries, limited data on social and environmental matters are made available in annual reports. However, based on previous corporate governance studies conducted in South Africa it appears that since the publication of the second King Report (King II) in 2002, most firms listed on the Johannesburg Securities Exchange (JSE) have improved their reporting on corporate governance issues of consideration. King II emphasised the importance of sound corporate governance, by focusing on the board of directors as the vocal point of the South African corporate governance system (IOD, 2002). The need for sound corporate governance was also highlighted during the global financial crisis which started in The global financial crisis had an adverse impact on the economies and financial markets of countries worldwide. As in the case of the Asian market crisis in 1998, most firms also reported weaker financial performance (Reinhart & Rogoff, 2008; Lee & Yeh, 2004; Johnson, Boone, Breach & Friedman, 2000: 151). In conjunction with the belief that ESG factors can have an impact on financial performance (UNEP FI, 2007), this study will focus be on the relationship between ESG risk management and firm performance. Given data constraints, attention will only be given to corporate governance issues. Previous researchers (Van Boxtel, 2009; Ho & Wong, 2001: 140) indicated an important relationship between a firm s ownership structure and corporate governance, especially

3 regarding institutional investors. Therefore, the importance of the proposed research is to examine the relationship between corporate governance, ownership structure and the performance of South African listed industrial firms before and after the global financial crisis. 2. Literature review 2.1 Responsible investing (RI) The history of RI dates back to the 18 th century Quakers who refused to profit from the slave trade, alcohol and weapon dealings. John Wesley ( ), the founder of the Methodist church stated that people should not engage in sinful trade or profit form the exploitation of others. In the 1920s the United Kingdom Methodist Church thus avoided investing in firms involved in the production of alcohol, tobacco and gambling as they regarded these practises as sinful. The first modern RI mutual fund, the Pioneer Fund was founded in 1928 and employed screening based on religious traditions (Renneboog, Ter Horst & Zhang, 2008: 1725). Since the 1960s, a series of social campaigns have made investors aware of the social and environmental consequences of their investments. The Pax World Fund, founded in 1971 in the United States, was created for investors opposed to the Vietnam War as well as militarism in general. The fund avoided investments in weapon contractors. In the 1980s, there was shareholder activism against South African firms, due to the system of apartheid. RI investors in Europe and the United States exerted pressure on firms doing business in South Africa to divert their operations to other countries (Renneboog et al., 2008: 1725). This trend toward become responsible when investing had a substantial impact on the institutional investment community, pension fund trustees, the managers of listed firms as well as society in a wider context (Solomon, 2007: 274). In 2005 the United Nations Secretary-General invited a group of the world s largest institutional investors to join the process of developing the Principles for Responsible Investment (PRI). Twenty institutional investors from 12 countries were represented and agreed to participate in the Investor Group. This Group was supported by a 70-person stakeholder group of experts. As a result of the meetings and discussions, the United Nations Principles for Responsible Investment (UN PRI) emerged. There are currently more than 800 investment institutions from 45 countries who have become signatories. The UN PRI entail that institutional investors have a duty to act in the best long-term interest of their beneficiaries. ESG factors can affect the performance of investment portfolios to varying degrees over time. By applying the Principles, the ownership practices and decision-making of investors may be better aligned with the broader objectives of society (UN PRI, 2010) RI strategies The European Social Investment forum describes ten different RI strategies, the most important of which relate to screening, shareholder activism and impact investing. Screening options for a RI portfolio can be divided into negative, positive and best-in-class screening strategies. Negative screening is exclusionary and the most basic form of choosing investments. This screening strategy entails that investors refrain form investing in securities from firms that produce undesirable products and services, as well as firms that operate in undesirable industries and countries. Firms are thus omitted based on certain ethical or ESG criteria. The investing decision usually entails a yes/no decision.

4 Responsible investors who follow this strategy will thus typically avoid investments in firms that are associated with the production and sale of weapons, tobacco and alcohol. In contrast, positive screening is an inclusionary portfolio construction strategy. This strategy is based on actively choosing investments that meet a range of ethical and ESG criteria and making conscious investment decisions that can deviate from conventional choices. In South Africa, criteria dealing with labour issues and broad-based black economic empowerment (BBBEE) are often employed as positive screens (Fung, Law & Yau, 2010: 28; Viviers, Bosch, Smit & Buijs, 2008: 39). Best-in-class screening refers to a combination of positive and negative screening strategies and often provides a practical way to integrate ESG issues in RI portfolios and increase financial returns (Fung et al. 2010: 28). Renneboog, Ter Horst and Zhang (2006: 1) indicated that mutual funds that employ a higher number of screens to model their investment universe received larger money inflows and performed better compared to focused funds. Shareholder activism entails that shareholders actively engage with management boards on a variety of ESG issues (Viviers et al., 2008: 39). It is a process of working with and advocating with firms to convince them to change some aspects of corporate behaviour. Most shareholder activism is cordial and done through discussion and resolutions at annual meetings. However, it can be confrontational, particularly when participants feel their concerns are not getting reasonable attention from corporate decision makers (Little, 2008). The third RI strategy is impact investing. This strategy entails that a specific worthy cause or activity are supported by financing it. The strategy is also called community investing, since financial resources are often invested to support underprivileged communities. Cause-based investors may seek a return at market rate or take a lower return in order to achieve a particular social return for society from their investment (Basso & Funari, 2003: 522; Chen 2001: 6) The state of RI worldwide The 2010 Report on Socially Responsible Investing Trends in the US indicated that RI has continued to grow at a faster pace than the broader universe of conventional investment assets under professional management. The report identified $3.07 trillion in total assets under professional management in the US that use at least one of three social investing strategies, namely the incorporation of ESG factors in portfolio construction and investment analysis, the filing of shareholder resolutions on ESG issues and deposits of investments that have a community investment focus. The number of US funds that incorporate ESG factors increased from 55 in 1995 to 493 in 2010 (US SIF, 2010). The European Social Investment Forum (EuroSIF) classifies RI strategies as core SRI and broad SRI. Core SRI consists of norm- and values-based exclusions as well as different forms of positive screens. Between 2007 and 2009 the core SRI grew with approximately 20.7%. Broad SRI is composed of three strategies, namely simple exclusions, engagement and integration. The growth of the broad SRI between 2007 and 2009 is approximately an astonishing 119%. The 2010 European SRI study estimates that the global SRI market has

5 reached approximately 6.9 trillion, with Europe holding the largest share of (EuroSIF, 2010). According to the International Finance Corporation (IFC) (2003) there is moderate demand for RI funds in emerging markets, especially in larger, financially more developed ones, such as Brazil and South Africa. South Africa is the largest emerging market RI country and is unique in many respects, including that it developed as a government-supported initiative and its BBBEE requirements (IFC, 2003). Concerning the state of RI in South Africa, Viviers (2007: 365) suggests that if RI is properly implemented in South Africa, it could serve as a valuable case study for other developing countries. However, a lot still remains to be done before this will become reality. Finlay (2004) indicated that in terms of RI, South Africa is a metaphorical big boat we are still trying to row with little oars and we have a long way to go before we reach the harbour gates and big seas. For many years growth in the RI market in South Africa has lagged behind its international counterparts. At present only approximately 1.04 percent of all assets under management in South Africa are managed according to RI principles (Giamporcaro, 2010:6). However, positive changes are starting to take place and interest in the field is steadily growing due to initiatives such as the FTSE/JSE socially responsible investing (SRI) index (Viviers et al., 2009: 3). This index was launched in May 2004 in response to the debate around sustainability in South Africa. It was a pioneering initiative amongst emerging markets. It consequently led to increased attention to RI in emerging markets (FTSE/JSE SRI index, 2010; Herringer, Firer & Viviers, 2009: 14). Another important driving force behind the growing awareness of RI in South Africa is the commitment shown by the largest local institutional investor, namely the Government Employees Pension Fund (GEPF). This fund was also one of the founding members of the UN PRI in 2006 (GEPF, 2010; Oliphant, 2010; WFE, 2010). In 2009, Eccles, De Jongh, Ndlovu and Smith (2009: 15) conducted a study on the materiality of ESG risks in South Africa. Uniquely South African aspects, such as BBBEE was added to the more conventional understanding of ESG risk management in the international arena. Table 1 indicates the perceptions of pension fund managers, asset managers and advisory service providers on the materiality of ESG issues in South Africa. Table 1: Perceptions on the materiality of ESG issues in South Africa Ranking Pension fund managers Asset managers Advisory service providers 1 Corporate governance Infrastructure development Infrastructure development 2 Sustainability Corporate governance Black economic empowerment and gender empowerment issues 3 Infrastructure development Black economic empowerment and gender empowerment issues Employee relations 4 HIV/AIDS Employee relations Corporate governance 5 Black economic empowerment and gender empowerment issues Source: Eccles et al. (2009: 15) Sustainability HIV/AIDS

6 As indicated in Table 1, corporate governance issues are seen as very important by South African pension fund officers, asset managers and advisory services providers. Pension fund officers ranked corporate governance first in terms of materiality, asset managers second and advisory service providers fourth (Eccles et al., 2009). The importance of sound corporate governance was also highlighted during the global financial crisis. In the following section, the concept corporate governance will thus be discussed in more detail. 2.2 The concept corporate governance If we are looking for solutions, it appears that sound governance, both of countries and of firms, is an absolute key to mitigating the negative effects of a global economic crisis. This comment by Moody-Stewart (2009) emphasises the importance of corporate governance, especially during a crisis period. Mallin (2007: 248) stated that corporate governance is relevant to all countries, regardless of the country s level of development or the predominant nature of equity ownership. Corporate governance is thus an important topic in a developing country such as South Africa. No single, globally accepted definition exists of corporate governance. According to Solomon (2007: 12) there are considerable differences depending on the country in which the research is being conducted. In South Africa, the King Reports on Corporate Governance used the formulation of the Cadbury Report as the working definition of corporate governance. Corporate governance was thus defined as the system by which firms are directed and controlled (Gertz, 2003: 115; IOD, 1994). This definition implies that the responsibility for the corporate governance of publicly owned firms lies with the boards of directors of these firms (Rossouw, Van der Watt & Malan, 2002: 289). The definition also depends on whether a narrow or broad view of corporate governance is taken. The narrow view of corporate governance is restricted to the relationship between a firm and its shareholders. This is the traditional finance paradigm that is expressed in the agency theory. The agency problem occurs when the ownership of a firm becomes separated from the control of the firm. The responsibility for the control of the firm shifted to the directors (agents) when the firm s owners (principals) no longer control the day-to-day operations of the firm. This situation creates the problem that a firm s directors or managers could abuse their control function to their own benefit and to the detriment of the owners (Rossouw et al., 2002: 289; Maher & Andersson, 1999: 5-6; Jensen & Meckling, 1976: 308). The broad view of corporate governance can be expressed in the stakeholder theory where the relationship between a firm and its owners (shareholders), as well as a broad range of other stakeholders (including amongst others employees, customers and creditors) should be considered (Fernando, 2009: 4; Solomon, 2007: 12; Maher & Andersson, 1999: 6). The broad view of corporate governance is related to the stewardship theory. The stewardship theory defines situations in which management are not motivated by individual goals, but rather act as stewards whose motives are aligned to the objectives of their principals. These stakeholders interests must therefore also be taken into consideration in the constitution and conduct of corporate governance. The broad view on corporate governance is gradually attracting greater attention as issues of corporate social responsibility and accountability of policy and practice are emphasised worldwide (Solo-

7 mon, 2007: 12; Collier & Roberts, 2001: 67; Maher & Andersson, 1999: 8; Davis, Schoorman & Donaldson, 1997: 21; Blair, 1995: 225). Corporate governance is concerned with both governance of firms from within (internal governance) and control over firms that are exercised from the outside (external control), such as judiciary control by the state (Fernando, 2009: 482; Mäntysaari, 2005: 19; Rossouw et al., 2002: 290). Internal corporate governance is important, since various firm role players are responsible for the efficient corporate governance or the lack thereof within firms. Literature indicated that the board of directors should be the vocal point of the corporate governance system (IOD, 2009). In this research, the focus will consequently be on internal corporate governance by mainly concentrating on board specific variables Corporate governance in South Africa South Africa has had a troubled and turbulent history, experiencing considerable social unrest and inequality aggravated by the policy of apartheid. In the 1990s extensive legislation was introduced which led to social and political transformation in the country. A committee of corporate governance was established in South Africa in The committee, chaired by Mervyn King, produced the first King Report on corporate governance in 1994 (Mallin, 2007: 248). The publication of the King Report I evoked unprecedented interest in corporate governance in South Africa. However, corporate governance was an issue of concern before the publication of this historical publication. In its broader sense, corporate governance has been at stake since the inception of the first publicly owned firms in South Africa more than a 100 years ago (Rossouw et al., 2002: 289; IOD, 1994). The King Report I contained some of the most far reaching recommendations at that time. The King Report I took an inclusive approach to corporate governance. According to an inclusive approach the firm should develop its strategies and conduct its operations while considering the wider community including customers, suppliers and employees (Mallin, 2007: 248). The King Report I included both financial and ethical dimensions of corporate governance, taking into account the current circumstances at the time within South Africa (Rossouw et al., 2002: 296). However, between 1994 and 2002 there were extensive changes in legislation and the King Report I needed to take account of these developments. Therefore, the King Report I was revised in 2002, necessitated by both local and international developments (Mallin, 2007: 248). The King Report II indicates the code of corporate practice and conduct for all firms listed on the JSE. The report provided information concerning the board of directors, internal risk management, internal audit, integrated sustainability reporting as well as accounting and auditing of publicly listed firms. The King Report II emphasises that the board of directors should be the centre point of the corporate governance system (Mangena & Chamisa, 2008: 31; IOD, 2002). The following recommendations of the King Report II (Mangena & Chamisa, 2008: 31; IOD, 2002; Rossouw et al., 2002: ) are of importance to this study: An unitary board with a balance between executive and non-executive directors (NEDs). The majority of directors should preferably be NEDs. An executive director is an individual who is involved in the day-to-day management and/or is in full time salaried employment of the firm or its subsidiaries. A NED is an individual who is not involved in the day to day management and is not a full-time salaried employee of the

8 firm or its subsidiaries. NEDs on the board of directors are important, since these independent individuals monitor the performance of management and where necessary, remove management members. Separation between the roles of the chairperson (who should preferably be an independent NED) and the chief executive officer (CEO). An independent director is a NED who is not representative of a shareowner who has the ability to control the firm, has not been employed by the firm, is not an immediate family member of a individual who has been employed by the firm in the past three years in an executive capacity, is not a professional advisor to the firm other than in director capacity, is not a significant supplier to the firm and has no significant contractual relationship with the firm. A substantial part of the total remuneration of executive directors should be performance-based; levels of remuneration should be sufficient to attract, retain and motivate executives of the quality required by the board. Firms should provide full disclosure of director remuneration on an individual basis. Performance-related elements of remuneration should constitute a substantial portion of the executives total remuneration packages. Formation of at least remuneration and audit committees which should be chaired by independent NEDs; board committees should be subject to regular evaluation by the board to ascertain their performance and effectiveness. Regular board meetings, at least once a quarter or more frequent. The number of board meetings and directors attendance should be disclosed in the annual report. Figure 1 provides an illustration of the expected corporate governance structure of South African firms, based on the recommendations of the King Report II on corporate governance. Figure 1: The expected corporate governance structure of South African firms Source: Adapted from Nova Nordisk (2007) Figure 1 indicates that the shareholders of South African firms elect a board of directors with a chairperson. The roles of the chairperson and CEO (head of the executive management) should be separated to avoid conflict of interests. Audit committees should monitor the board of directors and the compliance to the stated governance framework (IOD, 2002). The King Report II indicated that the extent of board monitoring is strengthened by

9 the presence of an audit committee, since the auditors are assumed to monitor management to protect the interests of shareholders (IOD, 2002). The code of corporate practices and conduct as stated by the King II became effective in respect of JSE listed firms whose financial years commenced on or after 1 March 2002 (IOD, 2002). Corporations compliance with King II was voluntary. However, the JSE Listing Requirements (2005) obliged listed firms to disclose the extent of compliance with King II in their annual reports. In the case of non-compliance, reasons should be provided (Mangena & Chamisa, 2008: 31). The King Report III was published in This third report on corporate governance in South Africa became necessary due to the new Companies Act (Number 71 of 2008) as well as changes in international governance trends. The focus of this report was on the importance of conducting annual firm reporting in an integrated manner. Therefore, financial results were put into perspective by also reporting on how a firm has both negatively and positively impacted on the economic life of the community in which it operated during the year being considered. Firms should now also indicate how they intend to enhance the positive aspects or eradicate the negative aspects in the following year (IOD, 2009). The King Report III became effective from 1 March Regarding the role and function of the board, the following recommendations of the King Report III (IOD, 2009) are of importance to this study: The board should act as the centre point for and custodian of corporate governance. The board should comprise a balance of power with the majority of independent NEDs. The board should elect a chairperson who is an independent NED. The CEO of the firm should not also fulfill the role of chairperson. The board should ensure that the firm has an independent audit committee. Firms should remunerate directors and executives fairly and disclose their remuneration packages. According to the King Report III (IOD, 2009) the credit crisis and the resulting global financial crisis is increasingly presented as a crisis of corporate governance worldwide. However, even though current problems are to a certain extent indicative of shortcomings in the global financial structural design, it should not be interpreted as a reflecting dysfunction in the broader South African or United Kingdom corporate governance models. In these models, value-based principles are followed and governance is applied, both in form and in substance. Therefore, it is important that South African policymakers focus their response to the crisis on the underlying sources of the problem. Possible sources can include defects in the South African and global financial regulatory frameworks. In response to the need for a sound governance measurement instrument, the Unit for Corporate Governance in Africa at the University of Stellenbosch Business School (USB) developed the Public Investment Corporation (PIC) corporate governance rating matrix. This matrix is a developmental tool, aimed at assisting firms to improve their corporate governance performance and reporting. The matrix encompasses environmental, social and governance focus areas, mainly focusing on governance. Variables considered are the board composition, individual directors, executive management, remuneration, shareholder treatment, related party transactions, auditing and accounting, disclosure and reporting, corporate behaviour, transformation, environmental behaviour, health and safety, corporate responsibility and corporate culture (Unit for Corporate Governance in Africa,

10 2010). After considering a wide range of available matrixes and measures, the Unit s corporate governance rating matrix was identified as the most comprehensive and well-tested in South Africa. After a discussion of the proposed research, the Unit has agreed that their matrix can be used to measure corporate governance in this study. 2.3 Ownership structure The relationship between ownership structure and corporate governance has received considerable attention in the finance literature. Therefore, in this study, ownership structure will also be considered. Hart (1995: ) indicated that in the absence of agency problems between shareholders and firm management, all individuals associated with the firm can be instructed to maximise profit or minimise cost or maximise net market value. No governance structure will be required to solve disagreements, since no disagreements occur. However, in reality, agency problems are present and governance structure does matter. Jensen and Meckling (1976: 305) applied the agency-theory to the modern firm. They thus formalised an idea that dates back as far as Adam Smith (1776), namely that when ownership and control are not fully coincident, there is potential for conflict of interest between controllers and owners. Ownership and control are rarely fully separated within any firm. The controllers often have some degree of ownership of the controlled firm s equity. Several owners also have some control over the firms they own, due to the size of their equity positions. Ownership structure, namely the identities of the firm s equity holders and the size of their equity positions is a potentially important element in corporate governance. An important step in understanding the reality of corporate governance in a given firm is thus to understand the ownership structure and the consequent potential to exercise power and influence over the firm (Fernando, 2009: 52; Denis & McConnell, 2003: 1-3). Previous researchers (Brown & Caylor, 2004; Maher & Andersson, 1999) also indicated that the performance of a firm is an important aspect to consider when conducting corporate governance research. In the following section, various performance measures will be discussed. 2.4 Firm performance Corporate governance mechanisms and their link to firm performance are debated in the economics, finance and organisational sciences literature, both at a theoretical and empirical level (Ramdani & Van Witteloostuinj, 2009: 2). Differences in countries corporate governance systems concerning the identity of owners, ownership concentration as well as the legislative and regulatory framework can have important implications for both economic and firm performance (Maher & Andersson, 1999: 17). The performance of firms can be measured by using accounting-based, market-based, cash flow as well as value-based performance measures. Accounting-based performance measures reflect a firm s past performance. The focus of the majority of these measures is on profitability. Classical management theorists considered profit maximisation as the legitimate objective of firms (Verweire & Berghe, 2005: 20-21). The first King Report stated that the profitability of firms must be amongst the important driving forces of

11 governance. If there is no profitability in a firm, none of the stakeholders will have any enduring interest (IOD, 1994). The two profitability measures that are mainly used to measure firm performance appear to be Return on Assets (ROA) and Return on Equity (ROE). In addition, the earnings per share (EPS) and the dividend payout ratio are also frequently used accounting-based performance measures (Verweire & Berghe, 2005: 21). These four accounting-based measures will be used in this study to measure performance. Market-based performance measures evaluate the market s perceptions of a firm s performance and risk. These ratios relate the firm s share price to its earnings and book value per share, giving an indication to managers of investors perceptions of the firm s past performance and prospects for the future. If a firm s liquidity, asset and debt management as well as profitability ratios are high, the market value ratios will probably also be high with the share price as high as can be expected (Moyer, McGuigan & Kretlow, 2009: 88; Brigham & Houston, 2004: 89). Total shareholder return (TSR) is a concept used to compare the performance of shares of different firms over time. It combines both share price appreciation and dividends paid to indicate the total return to the shareholder (Balsam, 2002: 32). In this study, the TSR of the South African listed industrial firms will be considered. The following commonly used market-value ratios will also be considered: the price-earnings ratio, price-to-book ratio and dividend yield. In addition, a multi-factor market price model will then be employed, such as the Fama and French three-factor model. The net cash flow of a firm generally differs from its accounting profit, which consequently has an influence on the measurement of a firm s performance. The reason for the difference is that some of the revenues and expenses indicated on the income statement were not paid in cash during the year (Brigham & Ehrhardt, 2008: 91; Brigham & Houston, 2004: 44-45). A firm s net cash flow is of importance concerning dividend payments, since dividends are paid in cash. The assets required for operational and production purposes are also often paid in cash. Over time, cash flows cannot be maintained unless depreciating fixed assets are replaced and new products are developed. Managers are thus not free to use cash flows as they please (Brigham & Houston, 2004: 44-46). Free cash flow (FCF) captures a firm s ability to generate cash from its operations and will be used in this study as a measure of firm performance. In addition, the cash flow per share measure will also be considered. Even though accounting data are used in many studies to determine firm performance, accounting data do have limitations. A firm s net cash flow differs from its accounting profit, since some of the income statement items were not paid in cash during the year. Share prices are also seldom brought into considered when discussing traditional accounting data. In response to these limitations, financial analysts developed the value-based performance measures Market Value Added (MVA) and Economic Value Added (EVA) (Brigham & Houston, 2004: 54). Shareholder wealth is maximised by maximising the difference between the market value of the firm s equity and the amount of equity capital supplied by investors, called MVA (Brigham & Ehrhardt, 2008: 103). EVA focuses on the value added by management during a given year (Brigham & Houston, 2004: 55). Based on the literature discussion, the theoretical framework is presented in the following section.

12 3. Theoretical framework After an extensive search, previous studies were found that considered corporate governance and firm performance on the African continent, while other studies considered corporate governance and firm performance during periods of financial crisis. However, as far as could be established, no previous study focused on the relationship between firm performance, ownership structure and corporate governance within South Africa during the recent global financial crisis. Therefore, this study will focus on the effect of corporate governance and ownership structure on the performance of South African listed industrial firms before and after the global financial crisis of 2007, with the board of directors as the centre point of corporate governance. The focus of the study is illustrated in Figure 2. Figure 2: Focus of the study Source: Researcher s own construction While prior studies mainly focused on profitability or share performance measures, this study will consider various measures of firm performance including accounting-based, market-based, cash flow as well as value-based measures. The King Reports indicated that the board of directors should be the centre point of corporate governance within South Africa. Therefore, board specific measures of corporate governance will be used in this study. Prior studies indicated that ownership structure has relations with firm performance and corporate governance (Imam & Malik, 2007:88; Preedanan, 2005). Therefore, ownership structure will also be included in this study. The global financial crisis of 2007 offers a unique, alternative setting for evaluating the relationship between various measures of firm performance, ownership structure and board specific measures of corporate governance. 4. Research questions Given the importance of corporate governance in an emerging market context and data considerations, the proposed PhD research will endeavour to answer the following questions: Do firms that exhibit better corporate governance perform better financially speaking? Did firms with better corporate governance mechanisms weather the storm (i.e. the global financial crisis) better?

13 Which corporate governance measures have a strong association with firm performance? 5. Research design and methodology This study will draw on phenomenological and positivistic research paradigms. A pilot study of 15 JSE listed industrial sector firms will be conducted to gain insight into the conformance and performance processes associated with enterprise governance. Thereafter a census of JSE listed industrial sector firms will be considered over the period The evaluation period will be divided into two periods, namely (before the crisis) and (during and after the crisis). The dependent and independent variables of the study are indicated in Table 2. Table 2: Dependent and independent variables of the study Dependent variable Measured by: Independent variables Measured by *: Firm performance Return on Assets (ROA) Corporate governance Board size Return on Equity (ROE) Earnings per share (EPS) Dividend payout ratio Price-earnings (P/E) ratio Non-executive directors (NEDs) on the board Number of NEDs on the audit committee Price-to-book ratio Remuneration of the directors Dividend yield Total shareholder return (TSR) Size of the audit committee CEO-chairman role duality Multi-factor price model market Regular board meetings Free Cash Flow (FCF) Ownership structure Ownership concentration Cash flow per share Economic Value Added (EVA) Market Value Added (MVA) Source: Researcher s own construction based on an extensive literature review * only a few selected measures of the USB matrix Structure of ownership In this study, the Spearman rank-order correlation will be used to indicate the relation and relative strength of the relationship between the variables. This measure will be used since it is less sensitive to outlier values and relies on fewer assumptions than the Pearson product-moment correlation. The Ordinary Least Square regression is used in many previous studies on corporate governance and will also be used in this study. Much of applied statistics may be viewed as an elaboration of the linear regression model and associated methods of least squares (Ramdani & Van Witteloostuijn, 2009:4). Therefore, in this study,

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