Governance practices and firm performance: Does shareholders’ proximity to management matter?

Abstract

This article investigates the link between corporate governance practices and firm performance, a topic that received a lot of attention by regulators, interest groups and academics. Research in this field has recently shifted from the analysis of one or more specific governance provisions to the analysis of multiple aspects of corporate governance. In fact, most studies now use corporate governance indexes that capture a wide range of corporate governance provisions (index-based studies). The objective and main contribution of this article is to revisit the governance–performance relationship while taking into account shareholders’ proximity to the locus of management. Shareholders’ proximity is defined based on ownership concentration and whether or not the dominant/controlling shareholder holds top executive positions in the firm. The lowest level of proximity is evidenced in firms with dispersed ownership, the highest level in controlled entities where the controlling shareholder holds the CEO and/or Chair positions. Governance is measured on a global scale using the Report on Business (ROB) index. The study is conducted over a 4-year period (2002–2005) using panel regressions in a two-stage least squares framework on a sample of Canadian publicly traded companies (470 firm-year observations). The results of the study show a positive relationship between the ROB global index (and sub-indexes) and Tobin’s Q whether ownership is dispersed or is concentrated in the hands of a dominant or controlling shareholder. Shareholders’ proximity to management has no impact on the governance–performance relationship. Overall, the results support a one-size-fits-all approach to governance, a policy adhesion that underlined the widespread adoption of Codes of Good Governance and legal/regulatory changes in the years following Enron’s collapse in the United States. Initiatives were in large part supported by a general consensus toward a stock market-centered model of governance. However, with the recent debt crisis in the United States, public perception has changed. The credibility of such a model for governing our institutions is called into question. Our study tempers these concerns by showing that governance controls should not account for ownership differences in the context of publicly traded companies. Instead, good governance practices based on an independent board of directors that promotes transparency and protects shareholders’ rights should be prioritized whether or not ownership is dispersed or concentrated. From a corporate governance standpoint, this study sheds new light on controlled companies. Our results show that improving transparency and control adds value to all publicly traded companies including those with concentrated ownership. Moreover, if holding the CEO and/or Chair positions has the potential to increase the power of a dominant/controlling shareholder, it does not seem to translate into higher agency costs to the firm, nor does the presence of insiders seems to affect the effectiveness of the controls in place. Publicly traded companies may therefore welcome dominant/controlling shareholders in key management positions without compromising on firm performance and value. In any case, putting in place good governance practices seems essential to ensure that managers/shareholders are kept in check and work in the best interests of their company.