Corporate Governance: The international journal of business in society

Corporate governance, complementarities and the value of a firm in an emerging market: the effect of market
imperfections
Kashif Rashid Sardar M.N. Islam
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effect of market imperfections", Corporate Governance: The international journal of business in society, Vol. 13 Iss 1 pp. 70 - 87
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 Corporate governance, complementarities
and the value of a firm in an emerging
market: the effect of market imperfections
Kashif Rashid and Sardar M.N. Islam
Kashif Rashid is an
Associate Professor at
CSES, Victoria University,
Melbourne, Australia.
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Sardar M.N. Islam is a
Professor at CSES, Victoria
University, Melbourne,
Australia.
Received December 2010
Accepted March 2011
The authors would like to
acknowledge that this paper
uses some materials including
the same data set and results
from an earlier work: Rashid, K.
and Islam S. (2008) Corporate
Governance and Firm Value:
Econometric Modelling and
Analysis of Emerging and
Developed Financial Markets,
UK: Emerald. The authors thank
Emerald for giving permission
for using these materials in this
paper.
PAGE 70 j CORPORATE GOVERNANCE
Abstract
Purpose – The purpose of this paper is to test the role of corporate governance instruments in affecting
the value of a firm (CGVF) in isolation and in combination of each other in a developing financial market
characterized by the existence of additional imperfections in this market.
Design/methodology/approach – Multiple regression analysis is performed on the data which are
collected by using stratified random sampling technique for the companies listed in the Kuala Lumpur
Stock Exchange for the years 2000-2003.
Findings – The results for the study suggest that majority shareholders expropriate minority
shareholders in this market. On the contrary, a bigger board, market liquidity, efficient utilization of
assets and informational efficiency in the financial system have a value adding impact on the firms’
performance. The results on the role of corporate governance instruments (board size and CEO duality)
in affecting the value of a firm in combination with each other suggest that the additional imperfections
prevalent in the selected market limit the strength of individual instruments in improving the marginal
benefits of each other, explaining the nature of business operations in this market.
Practical implications – The results provide new insights into the CGVF relationship and highlight the
importance of corporate governance provisions relevant to the firms of the developing market. These
results can be used by the regulatory authorities to make effective corporate governance policies.
Originality/value – This paper contributes to the literature by performing a comprehensive study by
using a correct proxy to value a firm and by performing additional tests for robustness to provide valid
results on the CGVF relationship. Furthermore, the role of additional imperfections and implications of
various business theories in explaining the relationship between corporate governance instruments (in
isolation and in combination) and the value of a firm is also analysed.
Keywords Corporate governance, Value analysis, Emerging markets, Malaysia, Board size,
CEO duality, Firms’ performance and developing market
Paper type Research paper
1. Introduction
Corporate governance plays a vital role in affecting firms’ performance in financial markets
(Dittmar et al., 2003; Nam and Nam, 2004). Important studies performed on firms in
developing financial markets are Jomo (1995), Claessens and Djankov (1998), Himmelberg
et al. (1999), Haniffa and Cooke (2000), Nagar et al. (2000), Morck et al. (2000), Suto (2003),
Klapper and Love (2004), Chang and Mansor (2005) and Tam and Tan (2007). Studies
relevant to the role of corporate governance in affecting firms’ performance in a developing
financial market suggest diverging views on the CGVF relationship. Studies in developing
markets as conducted by Wiwattanakantang (2001), Lins (2003) and Suto (2003), find a
positive relationship between ownership concentration and the value of a firm. Similarly,
Grossman and Hart (1982), and Kaplan and Minton (1994) find that majority shareholders
improve firms’ performance by solving the free rider problem. On the contrary, Nenova
(2003), Ahunwan (2003), Pinkowitz et al. (2003), Klapper and Love (2004) and Bebchuk et al.
j VOL. 13 NO. 1 2013, pp. 70-87, Q Emerald Group Publishing Limited, ISSN 1472-0701 DOI 10.1108/14720701311302422
 (2004) find that concentrated shareholding in a firm deteriorates shareholders’ value by
expropriating the rights of minority shareholders.
Kyereboah-Coleman and Biekpe (2006) in their studies of firms listed in Ghana, find a
positive relationship between board size and the value of a firm. On the other hand, Mak and
Kusnadi (2005) in their studies relevant on firms listed in Malaysia, Singapore and Nigeria
find a negative relationship between bigger board and firms’ performance in these
countries.
Similar to the role of board size, the role of leadership structure in affecting the value of a firm
also shows inconclusive results in a developing market. In their studies of firms listed in
Ghana, Kyereboah-Coleman and Biekpe (2006) show a negative relationship between the
value of a firm and the dual leadership structure. On the contrary, Haniffa and Cooke (2000)
suggest that dual leadership structure improves the value of a firm in the Malaysian market.
Furthermore, La Porta et al. (1998), Haniffa and Cooke (2000), Nagar et al. (2000), Morck
et al. (2000), Wiwattanakantang (2001), Lefort and Walker (2001), Anderson and Reeb
(2003), Lins (2003), Tam and Tan (2007) and Young et al. (2008) have focused on the role of
different corporate governance instruments in affecting the performance of a firm in
isolation. The abovementioned discussion suggests the following gap in the literature:
B need for performing a comprehensive study by using a correct proxy to value a firm in a
developing market;
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B performance of tests for complementarities of corporate governance instruments in

affecting the value of a firm in a developing market; and
B using additional tests for robustness to confirm the validity of regression results.
Based on the data for 60 companies listed in the Kuala Lumpur Stock Exchange, this paper
contributes to the literature and extends the recent research by Tam and Tan (2007) by
performing a comprehensive study and analyzing the true role of corporate governance
instruments in the presence of additional imperfections in the developing (Malaysian)
financial market. The relationship between CGVF is analyzed by using a broader dataset
and sophisticated econometric techniques. Furthermore, a correct proxy to value a firm,
additional tests for robustness and tests for complementarities of internal corporate
governance instruments are also performed. Finally, results for the study are used to suggest
value enhancing corporate governance and financial policies for firms in a developing
market.
The findings of the paper suggest that there is a negative relationship between the level of
concentrated shareholding and firms’ performance, as blockholders are involved in
extracting the private benefits. On the contrary, a bigger board creates value in the
developing market due to healthy conflicts among the board members. Finally, market
liquidity, efficiency of assets in creating returns and informational efficiency enhance
shareholders’ value in this market. The results pertinent to the role of corporate governance
mechanisms in combination with each other, suggest that internal corporate governance
instruments (board size and CEO duality) do not reduce the agency cost by improving the
marginal benefits of each other, as there are additional imperfections affecting this
relationship in the developing financial market.
Following the introduction, the rest of the paper is structured as follows. Section 2 discusses
the literature review, which is followed by hypotheses development in Section 3. Section 4
describes the methodology for the research. The econometric results are presented in
Section 5. Section 6 explains the robustness tests. Section 7 discusses the results related to
the hypotheses testing and section 8 explains the results pertinent to complementarities for
corporate governance instruments. Finally, Section 9 concludes the study.

2. Critical literature review and motivation for the study

Corporate governance is an important determinant in affecting the value of a firm in
developing financial markets (Klapper and Love, 2004; Tam and Tan, 2007). Corporate

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 71
 governance is associated with the protection of rights for shareholders and stakeholders in a
market. The corporate governance players in affecting shareholders’ value consist of
internal (managers, employees, customer, chief executive officer, chairman, suppliers and
board of directors) and external corporate governance instruments (majority shareholders,
regulatory authority and judiciary) (Morin and Jarrell, 2001). The basic need for corporate
governance arises due to incomplete contracting among the different players in a market
(Aghion and Bolton, 1992).
In developing financial markets, the role of majority shareholders as an external monitor is
important in decreasing the agency cost by disciplining the internal corporate governance
instruments (La Porta et al., 1998). Majority shareholders (blockholders) harm the interests of
minority shareholders and are involved in extracting private benefits from the assets of a
firm. In addition to the adverse role played by blockholders in developing markets, there are
also additional factors affecting the CGVF relationship in these markets (Nam and Nam,
2004).
These factors/imperfections in developing financial markets include high inflation, political
instability, poor infrastructure in a market and rudimentary public administration (Ahunwan,
2003). The additional imperfections trigger an agency cost in the developing market as local
and foreign investors cannot judge the true performance of a firm, which results in them
making irrational investment decisions. The strong regulatory authority can reduce the
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intensity of these imperfections, ultimately protecting shareholders’ rights in the market.

Malaysia is considered to be a developing financial market as it follows the hybrid system of
corporate governance. The characteristics of this system include concentrated
shareholding, rudimentary regulatory framework, high debt, less transparent financial
market and majority shareholders as an effective monitor (Wei, 2003). Furthermore,
compared to developed financial systems of the USA and the UK, there are higher market
imperfections and a lower level of protection of shareholders’ rights, which makes it qualify
as a developing financial market.
Corporate governance mechanisms in combination also perform an important task in
affecting the value of a firm in a developing financial market. These instruments are
Edgeworth complements as they improve the value for shareholders in combination by
reducing the agency cost created by each other (Heinrich, 2002). Internal and external
corporate governance instruments in combination should reduce the marginal cost and
improve the marginal benefits of each other, ultimately adding to shareholders’ value.
Additional imperfection/factors in a developing market also make the nature of the CGVF
relationship in this market different from a developed financial market (Ahunwan, 2003).
Furthermore, in the presence of these imperfections in the developing financial market, the
strength of individual corporate governance instrument in improving marginal benefits in
combination of each other is reduced. The presence of these factors also leads to
principal-agent conflicts resulting in a higher monitoring cost in the developing market
(Pereiro, 2002).
Different combinations of corporate governance instruments can be used to decrease the
agency cost in a financial market. These instruments in combination reduce the information
asymmetry and are management interventions, hostile takeovers, ownership structure and
market for corporate control (Heinrich, 2002). The Edgeworth combination of instruments in
affecting the value for shareholders in the outsider system of corporate governance
(developed financial market) are effective stock market, efficient regulatory regime, powerful
board, lower level of debt, and a transparent and efficient market. The external regulatory
regime in this market is effective and forces the internal corporate governance instruments to
improve the marginal benefits of each other.
Similarly, complementarities of corporate governance instruments in the hybrid system of
corporate governance have an important role in improving the marginal benefits of each
other in developing countries. The combination of instruments being used to add value to a
firm in the developing financial market are infant regulatory authority, efficient banking

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PAGE 72 CORPORATE GOVERNANCE VOL. 13 NO. 1 2013
 system, higher amount of debt, effective monitoring by majority shareholders and an illiquid
financial market (Heinrich, 1999).
Banks in the developing financial market can also perform the role of effective monitors of debt
to improve the value of a firm. Shareholders can control the debt and equity structure in a firm
and reduce the agency cost between creditors and management. Banks as a creditor prefer
low risk projects because in case of bankruptcy, the claims on earnings of firms are reimbursed
after the claims of shareholders are settled. This makes shareholders (equity holders) risk
lovers and creditors (banks) risk averse. The higher debt also triggers the need for more
representatives of creditors on the board, as this representation will result in defending the
rights of creditors, ultimately improving the shareholders’ value (Heinrich, 2002).
As argued before, internal corporate governance instruments can decrease the agency cost
from the market and protect the rights of shareholders. Firms’ specific factors to create
shareholders’ value include board, board size, CEO, market efficiency and the firms’
liquidity (Wei, 2003). The board has a significant role in protecting rights of shareholders
which results in a higher investment level in a firm. The board should neither be too big nor
too small for optimal value creation for shareholders (Nam and Nam, 2004). The board
should also fire the CEO if he does not produce value for shareholders.
Similar to the role of the board, the CEO can also protect the shareholders’ rights by
incorporating corporate governance provisions in a firm. The CEO heads the operations of
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an organization and ensures that the firm protects shareholders’ rights and creates value for
them (Rashid and Islam, 2008). The literature suggests that management can link the
performance of a firm with incentives to the CEO to further improve shareholders’ value
(Bhagat and Jefferis, 2002).
In addition to the role of individual corporate governance instruments, the characteristics of
the market, such as market efficiency, can decrease information asymmetry by
incorporating public and private information in the share prices (Colombo and Stanca,
2006). This leads to a higher shareholders’ value in financial markets. Similar to the market
efficiency, liquidity is also important in affecting the value for shareholders as it makes
buying and selling (market operations) easier for them, improving investors’ confidence and
firms’ performance.
As discussed previously in the current section, the Edgeworth combination of instruments
improves marginal benefits of each other in a developing financial market. These instruments
consist of high leverage, concentrated shareholding, weak regulatory authority, informational
inefficiency and illiquid market. Furthermore, in developing financial markets, board size and
CEO duality are internal corporate governance instruments and to create genuine value for
shareholders, these instruments are expected to be the Edgeworth complementary to each
other. Studies on an appropriate combination of internal corporate governance instruments are
missing in the literature, which implies that there is a need to test whether the combination of
corporate governance instruments, CEO duality and board size, improve the value for
shareholders or deteriorate the firms’ performance in a developing market.
The conceptual framework in Figure 1 shows the role of additional factors in affecting internal
corporate governance instruments and the value of a firm relationship. These instruments
include leadership structure (CEO duality), board size, debt and equity structure, majority
shareholders (blockholders) and market liquidity and efficiency. Furthermore, the impact of
these factors on combination of instruments (CEO duality and board size) in affecting the
value of a firm is also given.

3. Hypotheses testing
This section consists of hypotheses relevant to a model for corporate governance and the
value of a firm (CGVF) relationship in a developing market. The first hypothesis related to this
study is based on the negative role of majority shareholders and is stated as follows.
H1. Concentrated shareholding deteriorates firms’ performance in the developing
market.

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 73
 Figure 1 Conceptual framework
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The majority shareholders are an important corporate governance instrument in

implementing democratic provisions in the market (Kaplan and Minton, 1994).
Concentration of shareholding in developing financial markets has proved to be
detrimental to minority shareholders as these blockholders are involved in manipulating
the rights of minority shareholders. This expropriation takes place in forms of under and over
investment of the free cash flow (tunneling) in a developing financial market (Pinkowitz et al.
2003).
Under investment usually occurs when creditors’ benefits are associated with the generation
of high returns of the project. In case of investment in positive net present value projects, part
of the returns from these investments are also captured by creditors in these markets. To
stop the flow of these benefits to creditors, managers do not make healthy investments
(Rashid and Islam, 2008). The process by which the outflow of benefits to creditors is
stopped by not investing in value creating projects, is the under investment of the free cash
flow. This activity is harmful to minority shareholders as they do not get a proper return on
their investments in the firms of financial markets.
Tunneling in a developing financial market can also take the form of over investment of the
free cash flow. This form of expropriation occurs when managers invest in pet projects which
are related to their own private benefits. Managers involve themselves in over investment, as
they derive higher returns compared to just investing in projects with normal returns. These
abnormal returns are also shared by majority shareholders in a market, deteriorating the
value of a firm (Bebchuk et al., 2004; Colombo and Stanca, 2006).
The management of firms in developing financial markets do not diversify their investments
and generally opt for concentrated investment portfolios to acquire illegal benefits from their
investments (Ararat and Ugur, 2003; Nenova, 2003). The health of the bank as monitors
deteriorates because of risky and bad loans (loans yielding poor returns) made by the
management of these firms.
As discussed above, firms in a developing market are involved in tunneling or expropriation
of the rights of shareholders (Pinkowitz et al. 2003). This expropriation also occurs due to a
weak regulatory regime and cross and pyramidal shareholding in a developing financial
market. The regulatory authority in this market has connections with the top political families
of the country and they support each others’ interests (Pereiro, 2002; Ahunwan, 2003). The
management of these firms are also controlled by government officials. These officials do not
have appropriate management skills to run the organizations effectively and are involved in
extracting different types of private benefits from these firms (Gupta, 2005).

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PAGE 74 CORPORATE GOVERNANCE VOL. 13 NO. 1 2013
 Similar to the weak regulatory authority, there prevails an ineffective judiciary in developing
financial markets. The judiciary is neither optimally financed nor resourced to develop an
understanding about corporate crimes (Ahunwan, 2003). Furthermore, there is a lack of
proper libraries and guidance sessions for judges to improve their knowledge related to
corporate fraud in the financial market. The judiciary also makes biased decisions providing
benefits to the ruling class of the country. The developing financial market is neither
transparent nor financially stable, which increases the responsibility of judges to make
democratic decisions in this market. The judiciary should also stop the harmful actions of
managers and act as a neutral authority to improve the value of a firm in a developing
market.
The second hypothesis in this study is related to the role of CEO duality in affecting the value
of a firm. The hypothesis is stated as follows.
H2. The dual leadership structure deteriorates the value of a firm in a developing
financial market.

CEO duality is the mode of leadership structure in which a single person keeps both the top
positions of management i.e. CEO and chairman (Rashid and Islam, 2008). The dual
leadership structure (CEO duality) prevails in the firms of the developing market and there
are two theories related to the role of CEO duality in affecting the value of a firm. The first
theory explaining the nature of this relationship is the agency theory (Kyereboah-Coleman
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and Biekpe, 2006). This theory suggests that in a dual leadership structure, an
independence of the board making value adding decisions is harmed, which leads to the
poor performance by the management of a firm (Fama and Jensen, 1983).
Similarly, due to the domination of a CEO, the board cannot make rational decisions to provide
proper remuneration to the top management for theirextraordinary efforts. This leads to a loss of
investors’ confidence and an increase in agency cost incurred in the process of monitoring a
CEO, ultimately harming the interests of shareholders (Yermack, 1996). In addition to the above
discussion, a single person holding both positions (CEO and chairman) in a firm goes against
the principles in the literature on the CGVF relationship, as outside directors cannot resist the
detrimental decisions of a dominant CEO (Golden and Zajac, 2001).
The second theory related to the role of CEO duality in affecting the value of a firm is the
stewardship theory. The supporters of this theory suggest that the CEO works as a steward for
shareholders in financial markets (Lam and Lee, 2008). The interests of the CEO converge with
those of the shareholders, which results in improvement in the value of a firm. Due to the similar
interests of shareholders and CEO, the CEO makes healthy decisions and does not involve
himself in manipulating the rights of shareholders. Shareholders’ value can be further improved
by aligning the incentives of the CEO with his performance (Rashid and Islam, 2008).
The supporters of a dual leadership structure suggest that a single person holding both the
positions is cost effective because the firm pays a salary to just one individual. The firm with
this type of leadership structure creates value as a single person provides a unified
impression and controls firms’ operations by giving it a right direction.
The second type of leadership style is the non dual one. In this type of structure, roles of CEO
and chairman are performed by two different persons. The non dual structure is beneficial
for a firm as the independence of the board is strengthened. This provides the board an
authority and shareholders with a higher level of confidence (Higgs, 2003, p. 23). The non
dual leadership structure also adds value as due to the check and balance of chairman,
CEO cannot derive private benefits at an expense of shareholders’ value.
In the developing market, there is a concentrated shareholding and family ownership which
makes board vulnerable to the manipulation of CEO. So, we expect a negative relationship
between the value of a firm and the dual leadership structure in this market. The next
hypothesis in this study is related to the role of board size in affecting the firms’ performance.
This hypothesis is stated as follows.
H3. The bigger board improves the value of a firm in the developing market.

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 75
 Board size has a significant role in affecting the value of a firm in the financial market (Sah
and Stiglitz, 1991; Dalton and Dalton, 2005). There are two theories concerning the role of
board size in affecting shareholders’ value in developing financial markets. The first theory
related to the relationship between board size and the value of a firm is the agency theory
(Yermack, 1996). The theory suggests that bigger board deteriorates the value of a firm
because poor coordination and communication in a board leads to a passive monitoring by
the board members. This board is vulnerable to higher conflicts as there is less
understanding (cohesiveness) among the members of larger board (Jensen, 1993).
Furthermore, bigger board takes less aggressive and delayed decisions affecting the value
for shareholders in a negative manner (Nam and Nam, 2004). The higher strength in a board
makes difficult for all the members to reach to a single conclusion as they (board members)
do not get a proper turn to explain their point of view (Golden and Zajac, 2001).
The next theory related to the role of board size in affecting the shareholders’ value is the
stewardship theory. This theory suggests that the bigger board improves the value of a firm
as more members of the board can decide firms’ matters in a better manner. These
members have improved understandings related to the affairs of a corporation. Furthermore,
members in a larger board represent different operational areas of the firm and have diverse
backgrounds improving the value for shareholders in a financial market (Coles et al., 2008;
Linck et al., 2008). The higher members of the bigger board can also stop the irrational
decisions of CEO and restrict him from accepting detrimental projects for a firm. The board
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in this case is independent to decide the affairs of an organization and reduce under and
over investment of the free cash flow.
The board consists of both outside and inside directors. Outside directors are not the
employees of a firm and have higher wealth of knowledge (Fama and Jensen, 1983;
Baysinger and Butler, 1985). This enables them to make value enhancing financial
decisions. On the contrary, inside directors are employees of the same firm and have huge
experience related to firms’ operations. They provide internal information to outside directors
so that they (outsiders) can make robust financial decisions, especially in the presence of an
autocratic CEO (Stiles and Taylor, 1993). The bigger board has higher number of inside and
outside directors, which can lead to a better exchange of information and improved value of
a firm. The optimal combination of inside and outside directors can ensure better decisions
in a firm safeguarding the interests of shareholders.
We base our hypothesis on the stewardship theory and suggest that due to dominant CEOs
in a developing market, a bigger board improves shareholders’ value by resisting his
(CEO’s) value destroying decisions. This results in the protection of the rights of both minority
and majority shareholders improving the firms’ performance in a developing market. We also
suggest that in the presence of board and CEO, shareholders’ value is improved as both the
instruments (board size and CEO duality) constitute the internal corporate governance
mechanism. Furthermore, board size and CEO duality in combination reinforce the marginal
benefits of each other, ultimately improving the value of a firm.

4. Methodology
This section explains the methodology for the construction of variables, data collection
methods used, the multifactor model relevant to the research conducted and econometrics
pertinent to this study. The variables are presented in Table I and are as follows.

4.1 Construction of the variables

The dependent variable used in this study is proxy for the Tobin’s Q. This proxy is calculated
by adding market capitalization and total assets. Shareholders’ fund is subtracted from the
added value. The residual value is lastly divided by total assets to get the proxy for the value
of a company. Sarkar and Sarkar (2000) argue that due to a higher amount of institutional
debt in the developing market, correct calculation of its (institutional debt) replacement
value is difficult in this market. The current measure is a better proxy to value a firm as the

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 Table I Variables used for the study of a developing market (Malaysia)
Variables Proxied by Symbol Expected sign

Dependent variable
Value of a firm Tobin’s Q Mkt Cap þ TA 2 ShF=TA TQ
Independent variables
Return on total assets Return generated by the assets of a firm Rota Positive þ
Board size Number of directors in the board Log size Positive þ
Duality Dummy variable: Can take values of 0 and 1 Duality Negative 2
Agency cost Majority ownership in a firm AC Negative 2
Market capitalization Market capitalization of a firm Log Mc Positive þ
Price to book value ratio Price to book value ratio of a firm Pb Positive þ

Notes: Mkt Cap ¼ Marketcapitalization;TA=Totalassets; ShF=Shareholders’fund

replacement value of institutional debt is not used in the calculation for proxy for the Tobin’s
Q.
The methodology for construction of independent variables is as follows. The first
independent variable used in this study is ownership concentration (AC). The variable is
measured by taking into account the actual percentage of ownership by majority
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shareholders in a firm. In previous studies related to ownership concentration and the value
of a firm relationship, the variable (ownership concentration) is measured by using a dummy
variable (Klapper and Love, 2004). The current measure (AC) is a better representation of
agency cost compared to proxies used by previous researchers, as it will test the role of the
exact level of shareholding in affecting the firms’ performance. Shareholders’ concentration
is the proxy for the agency cost in the developing financial market and we expect a negative
relationship between the level of blockholding and the value of a firm.
The next independent variable used in this study is the board size (the number of directors
on the board). The methodology of constructing the variable is similar to
Kyereboah-Coleman and Biekpe (2006) in their studies related to the CGVF relationship.
A bigger board is expected to have a positive relationship with the firms’ performance in the
developing market as it reduces entrenchment of a CEO.
The third variable used in the model for the CGVF is CEO duality. This variable is used to test
the relationship between dual leadership structure and the value of a firm. The variable is
constructed by using a dummy variable. The value for the variable is 1 when both the roles
are held by a single person, otherwise the value for variable is 0. The methodology used in
constructing this variable is similar to Daily and Dalton (1995). The literature suggests that a
single person keeping both the positions is contrary to the corporate governance principles
and triggers agency costs in developing financial market. We also expect a negative
relationship between CEO duality and the value of a firm.
The control variables used in the model for the CGVF relationship are return on total assets,
price to book value ratio and market capitalization. These variables add robustness to the
model and are used to capture the role of factors in addition to corporate governance
variables, in affecting the value of a firm. The first control variable used in this study is the
return on total assets (ROTA). This variable is directly extracted from financial statements of
firms for the developing financial market. ROTA is expected to have a positive relationship
with the value of a firm as an optimal use of assets improves the value for shareholders in the
financial market. This variable is widely employed in the literature on CGVF as used by
Kyereboah-Coleman and Biekpe (2006).
The second control variable used in the CGVF relationship model is the price to book value
ratio (PBVR). The variable is used to analyze the role of correct valuation of securities and
investors’ confidence in a financial market. PBVR is extracted from the database of the Kuala
Lumpur Stock Exchange and is crossed-checked against the web sites of listed companies.
A higher value for the variable is expected to affect the value of a firm in a positive manner by
encouraging information efficiency in the market.

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 77
 The final control variable used in the model for the CGVF relationship is market capitalization.
This variable is used to analyze the role of liquidity in affecting the performance of a firm.
Market capitalization is widely used in the literature for corporate governance as a control
variable (Black et al., 2006). The literature supports a positive relationship of the variable with
the firms’ performance as a liquid market improves investors’ confidence, ultimately creating
shareholders’ value (Hartzell et al., 2008).

4.2 Data collection

The study adopted stratified random sampling, as the properties of all the listed companies
in the developing market are generalized by analyzing the properties of selected or sample
companies. The current study related to the CGVF relationship in the developing financial
market consists of internal corporate governance instruments and control variables. The
data for internal corporate governance instruments which include shareholders’
concentration (AC), CEO duality and board size, is collected from the Kuala Lumpur
Stock Exchange database and is confirmed with financial information available on the web
sites of companies. Similarly, control variables such as market capitalization, price to book
value ratio and return on total assets used in this study are collected from the same two
sources.

4.3 Multifactor model

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The multifactor corporate governance model (Rashid and Islam, 2008) used in the current
study is presented as follows.

Tobin’s Q ¼ fðLogSize; AC; Duality; Pb; Rota; LogMcÞ ð1Þ

The model shows the relationship between internal corporate governance instruments,
control variables and the value of a firm. The general form of the model is presented as
follows.

Yt ¼ C þ b1t logX1t þ b2t X2t þ b3t X3t þ b4t X4t þ b5t X5t þ b6t logX6t þ Ut ð2Þ

where:Yt (regressand)¼dependent (explained) variable;

C ¼ intercept;
bt (b1 2 b6) ¼ slopes of the independent (explanatory) variables;
Xit’s (regressors) ¼ independent variables;
t ¼ periods;
Ut ¼ error term;
b1 ¼ coefficient of board size;
b2 ¼ coefficient of agency cost;
b3 ¼ coefficient of CEO duality;
b4 ¼ coefficient of price to book value ratio;
b5 ¼ coefficient of return on total assets; and
b6 ¼ coefficient of market capitalization.

The sign of b1 is hypothesized as positive because the literature suggests a positive

relationship between firms’ performance and a bigger board. b2 is expected to be negative
as majority shareholders are hypothesized to harm the value of a firm in the developing
financial market. Similarly, b3 being the coefficient of CEO duality is also expected to have a
negative relationship with the value of a firm. In contrast, b4, b5 and b6 are hypothesized as
positive because the price to book value ratio, return on total assets and market
capitalization are expected to have a positive relationship with the shareholders’ value in the
developing financial market.

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 4.4 Econometric testing
Multiple regression analysis (Gujarati, 2003) is used in this study for testing the relationship
among the explained, explanatory and control variables used in the model for CGVF. The
general representation of the model is given in the equation below.
Yt ¼ a þ b1t X1t þ b2t X2t þ . . . þ bnt Xnt þ Ut ð3Þ

where:
Yt ¼ Tobin’s Q;
a ¼ intercept;
bit’s ¼ slopes of the independent variables (internal and control variables);
Xit’s ¼ independent variables; and
Ut ¼ error term.

The ordinary least square (OLS) estimation method is used to diminish the residuals of CGVF
model for the current study. OLS estimation reduces the error term of the model and
improves the explanatory power of the sample regression function to explain the maximum
portion of the population regression function (Cuthbertson, 1996).
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5. Results and analysis

The section includes results for the descriptive statistics and econometric estimation. The
results for the descriptive statistics are presented in Table II and are explained as follows.

5.1 Descriptive statistics

The descriptive statistics relevant to the developing financial market are used to analyse the
role of individual corporate governance instruments in creating value for the shareholders. A
univariate analysis is also performed to compare the results for the descriptives statistics of
corporate governance instruments in the developing financial market with the principles of
corporate governance. Furthermore, the descriptive statistics are analyzed by taking into
account the foundation of a hybrid system followed in the developing financial market.
The mean value for return on total assets is 4.79. This value shows that firms for the
developing market improve shareholders’ value. The assets of these firms are utilized
efficiently and optimally for the value creation for investors. Similarly, a positive value for the
price to book value ratio (1.15) shows that in the developing financial market, firms are willing
to pay a higher premium for assets operating in this market. In addition, this market is
efficient in correctly valuing securities by incorporating true information in the share prices.
The mean value for market capitalization is 439.19, which shows that the developing market
is liquid and therefore an efficient secondary market prevails. The result supports corporate
governance principles, but contradicts the findings of Heinrich (2002) who suggests that an
illiquid financial market in combination with majority shareholders improves the value of a

Table II Descriptive statistics for the developing market (Malaysia)

Variables Number Minimum Maximum Mean Std deviation

ROTA 240 257.56 54.99 4.79 9.05

PB 240 0.29 8.32 1.15 0.90
MC 240 12.00 11692.00 439.19 1248.99
Debt/equity ratio 240 22.57 733.17 35.47 63.77
CEO Duality 240 0.00 1.00 0.26 0.44
Board Size 240 5.00 12.00 8.05 1.71
AC 240 4.90 62.40 34.61 13.86
TQ 240 0.37 3.96 1.03 0.46

Source: Authors’ estimates

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 79
 firm. Similarly, the mean value for board size is 8.05, which shows that board in the
developing market is optimal (strength of board members lies between 7 and 9). The result
depicts that the value of a firm is improved as the board makes timely and rational decisions
reducing the agency cost of the firm.
Finally, the mean value for ownership concentration for firms of the developing financial
market is 34.61. This value shows that there is a high level of ownership concentration and
potential agency cost because of the blockholding in this market. The blockholders can play
a prominent role in improving the shareholders’ value of a firm by effectively monitoring the
firm. The result supports the foundation of the developing market as there is a concentrated
shareholding in the firms of this market (hybrid system).
The mean value for the dependent variable (Tobin’s Q) in the developing financial market is
1.03. This value is greater than 1 which shows that firms of the developing market are
financially strong and improve the value for the shareholders.

5.2 Econometric testing

The model for the developing financial market is selected on the basis of strong diagnostics
and the high value for the R squared. Models with different functional forms and alternate
specifications are tried and the model with best functional form and strong diagnostics is
selected for the study.
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The selected model for the developing financial market has an unequal variance of the error
term. This unequal variance gives rise to the heteroscedasticity in the model which affects
the validity of the results for the t and F statistics (Gujarati, 2003). The ordinary least square
(OLS) estimators are transformed into the generalized least square (GLS) estimators by
giving the white diagonal treatment to the CGVF model. This treatment enabled us to make
correct decisions related to the validity of alternate hypotheses in the study (Brooks, 2002).
Similarly, the test for the variance inflation factor (VIF) to detect multicollinearity in the model
for CGVF is also performed. The results of this test are presented in Table III. This result
shows that there is a lack of multicollinearity in the model for the developing financial market
as value for the VIF for an individual independent variable varies from 1.02 to 1.13.
The value for the R squared in the CGVF model depicts that the independent variables in this
model explain 75 percent variation in the dependent variable. The value for the error term
shows that 25 percent of the variation in the dependent variable remains unexplained by the
independent variables of this model. The value for the F statistic is 116.68 and is statistically
significant, endorsing the stability and reliability of the model for the CGVF relationship in the
developing financial market. These results are presented in Table IV.

6. Robustness tests
Tests to verify the validity of regression results are also performed. These are robustness
tests for the model of the CGVF relationship and include incremental regression analysis and
endogeneity test.

Table III Variance inflation factors for the developing market (Malaysia)
Variables Variance inflation factor

Board size 1.09

Market capitalization 1.13
Agency cost 1.02
Return on total asset 1.09
Price to book value ratio 1.02
CEO duality 1.03

Source; Authors’ estimates

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 Table IV Results for the model relevant for the developing financial market
Malaysian model
Variables Coefficients T statistics

Constant 20.01 20.09

Log board size 0.18** 3.51**
Log market capitalization 0.03** 2.44**
CEO duality 0.05 (1.59)
Price to book value ratio 43.44** 5.43**
Return on total assets 1.09* 1.76*
Agency cost 20.19* 22.15**
R-squared 0.75
Adjusted R-squared 0.74
Mean dependent variable 1.03
F-statistic 116.68**

Notes: * Represents the significance of a variable at 10 percent significance level; ** represents the
significance of a variable at 5 percent significance level; total number of observation for individual
models ¼ 240
Source: Authors’ estimates

6.1 Incremental regression

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The test for the importance of independent variables in the model for CGVF is performed by
removing the independent variables on an individual basis and capturing the change in the
value for the R squared (performing incremental regression analysis). The result is presented
in Table V and shows that removal of the price to book value ratio has caused a significant
change in the value for the R squared (portion of dependent variable explained by the
independent variables) as this value is reduced from 75 percent to 6 percent. The result
reveals that correct valuation of assets and informational efficiency in the developing market
are the most important corporate governance provisions in affecting shareholders’ wealth.

6.2 Endogeneity test

The literature on the CGVF relationship suggests a possibility of two-way relationships
between ownership concentration and the value of a firm. The value of a firm affects the level
of concentrated shareholding in a market. Similarly, majority shareholders can affect
shareholders’ value as they have an incentive to monitor because of larger financial interests
in a firm. The endogeneity among the variables disturbs the CGVF relationship by making
this relationship insignificant (Bauer et al. 2003). The current study will perform tests to
detect the two-way relationships between ownership concentration and the value of a firm. In
case of the presence of endogeneity in the model, a suitable treatment will be given to
eliminate this problem.
The tests to detect endogeneity are performed by using a two step process. In the first step,
shareholders’ concentration (agency cost) is used as a dependent variable and its
relationship with other independent variables is tested calculating the error term of the
model. In the next model, relationship between the value of a firm and residual (error term) is
tested. The result of this test shows the lack of a relationship between firms’ performance
and the error term. This endorses the lack of endogeneity in the model implying that the
results of the hypotheses testing are valid.

Table V Test for incremental regression

Model Malaysia

R-squared (original) 0.75

R-squared (after the removal of Pb) 0.06

Source: Authors’ estimates

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 81
 7. Results for hypotheses testing
The results for hypotheses testing relevant for the CGVF model for the developing market are
explained in this section. The relevant model (Rashid and Islam, 2008) is presented in
Table IV and is stated as follows.

Yt ¼ C þ b1t logX1t þ b2t X2t þ b3t X3t þ b4t X4t þ b5t X5t þ b6t logX6t þ Ut ð4Þ

The model mentioned above explains the relationship between firms’ performance, internal
corporate governance instruments and control variables in the developing (Malaysian)
financial market. The estimated form for the CGVF model is presented as follows.

TQ ¼ 20:01 þ 0:18 Size 2 0:19 AC þ 0:05 Duality þ 43:44 Pb þ 1:09 Rota þ 0:03 Mc
ð20:09Þ ð3:51Þ** ð22:15Þ** ð1:59Þ ð5:43Þ** ð1:76Þ* ð2:44Þ** ð5Þ
R2 ¼ 0:75

The values for coefficients are in the first row. Below these are the values for t statistics in
parentheses. The single asterisk (*) and double asterisk (**) represent the significance of
variables at a 10 percent and 5 percent level of significance respectively.

7.1 Concentrated shareholding

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The first hypothesis in this study (H1) is related to the role of majority shareholders in
affecting the firms’ performance. The hypothesis is accepted as the negative relationship
between concentrated shareholding and the value of a firm is significant with the value of
coefficient as 2 0.19. The result supports the arguments by La Porta et al. (1997, 1998), Nam
and Nam (2004) and Young et al. (2008) as majority shareholders manipulate the minority
shareholders in the developing financial market by involving themselves in tunneling.
Tunneling in this market takes place by under and over investment of the free cash flow as
suggested by Colombo and Stanca (2006). In addition, cross and pyramidal shareholding in
the developing market resist regulatory institutions to play an effective role of monitors in this
market. Additional imperfections such as inflation, political instability, poor infrastructure,
informational inefficient market and higher level of information asymmetry affect the CGVF
relationship and harm the rights for minority shareholders in the developing financial market.
The result also provides evidence related to the principal-principal (majority and minority
shareholders) conflicts. The divergence between majority and minority shareholders can be
reduced by addressing it with an effective corporate law. Debt can also manage the agency
cost between managers (agent) and majority shareholders (principal) by reducing the
amount of cash available at the discretion of managers (Jensen, 1986).

7.2 CEO duality

The next hypothesis (H2) in the current study is relevant to the role of CEO duality in affecting
the value of a firm. The hypothesis is rejected as there is a lack of a statistical relationship
between the variable (CEO duality) and firms’ performance in the developing financial
market.

7.3 Board size

The hypothesis (H3) related to the constructive role of a bigger board in affecting the value of
a firm (Tobin’s Q) is accepted, as there is a positive relationship between the variable (board
size) and the firms’ performance in the developing market. The relationship is endorsed at a
5 percent significance level supporting the argument by Kyereboah-Coleman and Biekpe
(2006). The incremental addition in the board of firms for the developing market affects the
value of a firm in a positive manner due to an optimal combination of inside and outside
directors and representatives of creditors on the board. The result further implies that a
larger board has a higher number of inside and outside directors and an improved expertise
in making the value enhancing decisions in the developing market (Pfeffer, 1972; Zahra and
Pearce, 1989).

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 7.4 Return on total assets
There is a positive relationship between the return on total assets and firms’ performance at a
10 percent significance level with the value of coefficient as 1.09. The relationship shows that
assets of firms generate positive returns for shareholders improving their wealth in the
developing market (Chen et al., 2007).

7.5 Price to book value ratio

There exists a positive relationship between the value of a firm and the price to book value
ratio at a 5 percent significance level with the value of coefficient as 43.44. The result proves
that assets of firms for the developing financial market have a higher value which improves
investors’ confidence in this market. The result also shows that the developing market is
efficient in terms of valuing securities correctly and incorporating the true information (public
and private) in the share prices.

7.6 Market capitalization

Similar to the relationship between the return on total assets and the price to book value ratio
with the firms’ performance, there is a positive relationship between the value of a firm and its
market capitalization. The result shows that liquidity in the developing market improves
shareholders’ value. This finding is consistent with Nam and Nam (2004), but contradicts the
foundation of the developing market. The foundation advocates for the presence of illiquid
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market and concentrated shareholding, as these instruments in combination improve

marginal benefits of each other and reduce the agency cost from the market (Heinrich, 2002).

8. Results of complementarities for corporate governance instruments

The tests for complementarities of corporate governance instruments are performed in the
model for the developing financial market to suggest a value adding policy, and are
presented in Tables VI and VII. In these tests, internal corporate governance instruments
used in the model for CGVF relationship (CEO duality and board size) are removed on an
individual basis. The effect on the significance of board size and the value of a firm
relationship was noticed after the removal of CEO duality from the model. Similarly, the effect
on the validity of the relationship between CEO duality and the value of a firm was analysed
after the removal of board size from the model for CGVF.
There was no effect on the significance of board size and the value of a firm relationship after
the removal of CEO duality from the CGVF relationship model. Similarly, there was no change
in the CEO duality and the value of a firm relationship after board size was removed from the
model for the developing market. These tests show that both CEO duality and board size do
not decrease the marginal costs of each other, affecting the value of a firm in a negative

Table VI Effects on board size after the removal of CEO duality

Malaysian model
Variables Coefficients T statistics

Constant 0.02 0.22

Log board size 0.17** 3.31**
Log market capitalization 0.03** 2.47**
Price to book value ratio 43.36** 5.44**
Return on total assets 1.12* 1.82*
Agency cost 20.19** 22.18**
R-squared 0.74
Adjusted R-squared 0.74
Mean dependent variable 1.03
F-statistic 138.86**

Notes: * Represents the significance of a variable at 10 percent significance level; ** Represents the
significance of a variable at 5 percent significance level
Source: Authors’ estimates

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE PAGE 83
 Table VII Effects on CEO duality after the removal of board size
Malaysian model
Variables Coefficient T statistic

Constant 0.33** 4.54**

Log market capitalization 0.03** 2.83**
CEO duality 0.03 1.20
Price to book value ratio 43.51** 5.40**
Return on total assets 1.14* 1.81*
Agency cost 20.18** 22.12**
R-squared 0.74
Adjusted R-squared 0.73
Mean dependent variable 1.03
F-statistic 135.08**

Notes: * Represents the significance of a variable at 10 percent significance level; ** represents the
significance of a variable at 5 percent significance level
Source: Authors’ estimates

manner. The combination of these internal corporate governance instruments does not
improve marginal benefits of each other, as the additional imperfections present in the
developing financial market affect the CGVF relationship. These imperfections do not allow
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the internal corporate governance instruments (CEO duality and board size) to reinforce the
positive effects of each other, resulting in the non-existence of the complementarities of the
instruments in the selected market.

9. Conclusion
The study has contributed to the literature by revisiting the CGVF relationship in the
developing financial market. An integrated model considering important factors relevant for
the developing financial market is constructed. The results for this model imply that
concentrated shareholding is deterimental to the value for shareholders in the developing
market. The strong regulatory regime can improve the value of a firm by protecting the rights
of minority shareholders. On the contrary, bigger board should be preferred by the firms of
the developing market as board members are involved in constructive activities improving
the firms’ performance.
The results also suggest that optimal utilization of assets, liquid and informational efficient
market have a value adding impact on the performance of a firm in the developing market.
Regulatory authorities in this market can further improve shareholders’ value by encouraging
the operations of a secondary market. The results prove that the conceptual framework built
in this study is successful in incorporating important factors in affecting the CGVF
relationship in the selected market. Finally, additional imperfections prevalent in the
developing financial market deteriorate shareholders’ value by limiting the role of board size
and CEO duality to improve the marginal benefits of each other explaining the nature of
business operations in this market. The limitations of the paper suggest that the inclusion of
new control variables and corporate governance instruments and their tests for
complementarities can lead us to have a different nature of the relationship between the
CGVF and new policy implications.

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countries’’, The European Journal of Finance, Vol. 4 No. 3, pp. 291-304.
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firms’’, Journal of Financial Economics, Vol. 48 No. 1, pp. 35-54.
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Hermalin, B. and Weisbach, M. (1991), ‘‘The effects of board composition and direct incentives on firm
performance’’, Financial Management, Vol. 20 No. 4, pp. 101-12.
White, J. and Ingrassia, P. (1992), ‘‘Board ousts managers at GM; Takes control of crucial committee’’,
The Wall Street Journal, April 7, p. A1, A8.

Corresponding author
Kashif Rashid can be contacted at: Kashifm001@yahoo.com

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