The Impact of Corporate Governance Practices on Firms´ Financial Performance: Evidence from Malaysian Companies

Abstract

I. Introduction The East Asian financial crisis of 1997-98 demonstrated the importance of effective corporate governance in developing countries (Krugman 1994; Radelet and Sachs 1998; Rasiah 1999). Malaysia was adversely affected by this financial crisis. The contraction of the Malaysian economy, along with instability in the exchange rate and a marked decline in share prices, adversely affected the corporate sector. This resulted in considerable retrenchment and downsizing of operations, and the closure of many firms. Poor governance standards in both private and government-owned firms were blamed in part for the East Asian financial crisis. In Asia, corporations tend to follow the insider model, with the dominant control held by the original owners and large shareholders (Sycip 1998; Yamazawa 1998). The erosion of investor confidence was identified as one of the major factors that exacerbated the financial crisis in Malaysia and other Asian countries. Many commentators, such as Noordin (1999b), argued that the erosion of investor confidence in Malaysia was brought about by the country's poor corporate governance standards and a lack of transparency in the financial system. Therefore, the restoration of confidence in the economy by investors will rely on improvements in corporate governance standards, including the adoption of transparency as an important strategy in corporate management. With the economic recovery of most East Asian countries, attention has understandably been drawn to addressing and researching the underlying issues and factors that led to the crisis, with a view to learning how to prevent a recurrence of the crisis. The primary purpose of this study is to identify, and contribute to current knowledge on, corporate governance practices that affect, either positively or negatively, the rate of return on investments in firms. In this context, the objectives of this article are to briefly discuss the current state of corporate practices of firms in Malaysia, and compare these practices with those of developed countries, such as the United States and the United Kingdom, and to establish corporate governance factors that significantly influence the financial performance of firms in Malaysia. A related objective of this article is to indicate the corporate governance practices which do not significantly influence the financial performance of companies in Malaysia. The next section of the article contains a brief literature review on the topic. This is followed by a depiction of the methods and procedures used for this empirical study. The results and conclusions follow. II. Literature Review II.1 The Role of Lenders in Corporate Governance The role of lenders as a force in corporate governance has yet to be extensively analysed (Prigge 1998). Lenders are interested in the repayment of credit, in accordance with the credit contract. Since the management's actions are one of the factors determining repayment, lenders may be motivated to carry out monitoring. Bilimoria (1997) found evidence to indicate that the Chief Executive Officers (CEOs) of highly leveraged firms were paid less long-term emoluments. Using three criteria--total voting power at the general meeting, chairmanship on the supervisory board, and liabilities owed to banks--Perlitz and Seger (1994) classify a sample of 110 listed industry companies into two groups: (1) those companies in which banks exert great potential influence on (comprising fifty-eight companies); and (2) those companies in which banks only have a small potential influence (comprising fifty-two companies). They found that the former group of companies has significantly lower profitability and growth than the latter group of companies. Similarly, Cable (1985) and Nibler (1995) discover a positive relationship between apparent bank influence on companies and the profitability and growth of companies. However, Chirinko and Elston (1996) did not find any significant relationship between bank influence and a company's earnings. …