Corporate Governance, Ownership Structure and Firm Performance

Mediation Models and Dynamic Approaches

Hoang N. Pham, Sardar M. N. Islam

• Publisher: Routledge
• Year: 2022
• ISBN:
  9781000540338
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Unternehmensführung

The relationship between ownership structure and firm performance has been studied extensively in corporate finance and corporate governance literature. Nevertheless, the mediation (path) analysis to examine the issue can be adopted as a new approach to explain why and how ownership structure is related to firm performance and vice versa. This approach calls for full recognition of the roles of agency costs and corporate risk-taking as essential mediating variables in the bi-directional and mediated relationship between ownership structure and firm performance.

Based on the agency theory, corporate risk management theory and accounting for the dynamic endogeneity in the ownership–performance relationship, this book develops two-mediator mediation models, including recursive and non-recursive mediation models, to investigate the ownership structure–firm performance relationship. It is demonstrated that agency costs and corporate risk-taking are the 'missing links' in the ownership structure–firm performance relationship. Hence, this book brings into attention the mediation and dynamic approach to this issue and enhances the knowledge of the mechanisms for improving firm's financial performance.

This book will be of interest to corporate finance, management and economics researchers and policy makers. Post-graduate research students in corporate governance and corporate finance will also find this book beneficial to the application of econometrics into multi-dimensional and complex issues of the firm, including ownership structure, agency problems, corporate risk management and financial performance.

1 Corporate Governance, Ownership Structure and Firm Performance An Introduction

DOI: 10.4324/9781003255741-1

1.1 Background of the Research

The relationship between ownership structure and firm performance has been studied extensively in corporate finance and governance literature. The adoption of mediation (path) analysis to examine the issue has emerged recently as a new approach to explain why and how ownership structure is related to firm performance. In addition to the work of Le and Buck (2011) on the mediating role of agency costs on the relationship between government ownership and firm performance, there is some other relevant literature on the issue (to be introduced in Chapter 2). Some more recent research that uses the mediation approach to consider the associations between ownership structure and firm performance is that of Wahba and Elsayed (2015). However, firm performance is considered in Wahba and Elsayed (2015) as the mediating variable for the effect of corporate social responsibility on institutional ownership. In the context of Bangladesh, Rashid (2020) examines the mediating role of board characteristics on the relationship between ownership structure and firm performance; the authors find that the impact of ownership structure on firm performance is partially mediated by board size and board independence. Further research in this direction is essential in order to understand the associations between ownership structure and firm performance. Thus, this book studies this relationship through a new mediation approach integrated with a dynamic approach.

It is well established in the literature that ownership structure does matter and that ownership structure and firm performance affect each other. The ownership structure of firms is one of the core internal characteristics of an effective corporate governance framework, making noticeable distinctions in governance systems across countries (Denis, 2010, Liang and Lin, 2011). The performance of a firm can be influenced by its ownership structure for several reasons:

1. owners have different levels of power, incentives and ability to monitor managers due to differences in their identities, concentration and resource endowments; and
2. owners have varying goals for their involvement in firms, resulting in different effects on firm performance (Douma et al., 2006). In turn, ownership structure is also affected by firm performance because they are endogenous, as claimed in many recent works such as those of Bhagat and Jefferis (2002), Bhagat et al. (2010) and Firth and Rui (2012), among others.

However, there is still limited knowledge on two aspects of this relationship in the literature. First, there is still little attention in the literature on the mediation channels between ownership structure and firm performance. It is implicitly assumed in many studies that firm performance is directly affected by ownership structure. Consequently, it is questionable whether there are underlying forces that intervene the impact of ownership structure on firm performance.¹ Moreover, when the mediation approach is not applied, the estimated coefficients on ownership structure only indicate the total effects of ownership structure on firm performance. In contrast, the other types of effects, such as indirect and direct effects, are not identified. Therefore, this book adopts a mediation approach in order to examine the relationship between ownership structure and firm performance.

Secondly, there is little literature on the non-contemporaneous or dynamic interrelationship between ownership structure and firm performance. It is likely that the current-year ownership structure can be affected by previous-year firm performance, while firm performance in this year can also be affected by ownership structure in the last year. This is termed the ‘lead–lag’ relationship between ownership structure and firm performance (Hu and Izumida, 2008). The dynamic relationship between current governance and past firm performance is an aspect of endogeneity that is often ignored in the literature, which may result in biased estimates (Wintoki et al., 2012). It is thus plausible to argue that there is still a large gap in the literature that investigates the co-deterministic relationship between ownership structure and firm performance from a dynamic perspective.

Consistent with Le and Buck (2011), this book firstly argues that agency cost is a ‘missing link’ in the relationship between ownership structure and firm performance. Agency theory suggests that the relationship between firm performance and ownership structure is closely associated with agency costs. Different forms of ownership may have different agency costs. In turn, agency costs can adversely affect firm performance (Brown et al., 2011).

Agency theory also suggests a link between equity owners and corporate risk-taking. Shareholders have different risk preferences; for example, managers are commonly regarded as risk-averse shareholders, since their human capital invested in the firm is not diversified (Himmelberg et al., 1999). It can be argued that these differences influence the risk-taking behaviours of the firm. In addition, it is well documented in corporate risk management theory that risks are closely associated with firm performance. For example, ‘high risk–high return’ is a hypothesis in this connection. As a result, an issue of concern is whether there is a continual connection between ownership structure, corporate risk-taking and firm performance. It is thus argued in this book that corporate risk-taking is another ‘missing link’ between ownership structure and firm performance.

Furthermore, this book attempts to examine the mediated relationship between ownership structure and firm performance in the framework of the non-contemporaneous interdependence between them. Thus, the direct effect of previous-year firm performance on current-year ownership structure is also examined, in addition to the mediated effects of previous-year ownership structure on current-year firm performance. While prior studies focus mainly on the contemporaneous relationship between ownership structure and firm performance from a static perspective (Hu and Izumida, 2008), this study uses a combination of the mediation approach with a dynamic perspective to produce new insights into the nature of the ownership–performance relationship.

On this basis, this book focuses on

1. the indirect effects of three equity ownership identities (government ownership, insider ownership and foreign ownership), through two mediating variables (agency costs and corporate risk-taking), on firm performance (return on assets or Tobin's Q);
2. the non-contemporaneous feedback effect of firm performance on ownership structure; and
3. the total effect of ownership structure on firm performance.

This book examines the issue from the context of the stock market in the developing and transition economy of Vietnam. Vietnam has been chosen as the case study for several reasons, namely,

1. no prior research has been undertaken on the mediated relationship between ownership structure and performance of Vietnamese listed firms;
2. the relationship between equity ownership and firm performance is still an issue of great concern and heated debate in this country during the process of the privatisation of state-owned enterprises; and, more importantly,
3. Vietnam is unique in having a young stock market associated with the privatisation programs of the state-owned enterprises. Under such circumstances, it provides all the variables of interest needed to develop the empirical models used in this study (see Section 1.3 for the details of the country-specific characteristics).

1.2 Research Problems and Motivation for Further Study

There remained opposing views about this association between ownership structure and firm performance until recently. For instance, the impact of ownership structure on firm performance has a long tradition of academic research, at least since Berle and Means (1932) emphasised managerial ownership and the separation of ownership and control. Under the ‘alignment of interest effect’ hypothesis (Jensen and Meckling, 1976), the higher the level of managerial ownership, the better firm performance is. On the contrary, the ‘entrenchment effect’ hypothesis postulates that the impact of managerial ownership becomes negative when managerial ownership reaches a certain level because managers will then become involved in non-maximising profit activities (Shleifer and Vishny, 2008). While many authors such as Megginson et al. (2012) and Djankov and Murrell (2002) argue that government ownership is inefficient and negative for firm performance, other authors, such as Tian and Estrin (2008) and Vaaler and Schrage (2009), claim that government ownership at certain levels helps improve firm performance.

Moreover, most empirical research on the issue has applied the direct approach, that is, ownership structure directly affects firm performance. As already mentioned, it can be argued that the direct approach yields a limited understanding of this relationship because the indirect effects of ownership structure via potential mediating variables are not considered. Hence, the empirical models developed in previous studies may not be suitable if the indirect channels of the effect of ownership structure exist in reality.

In this connection, it can be inferred from agency theory that the relation between firm performance and ownership structure is closely associated with agency costs because different forms of ownership may have different levels of agency costs. In turn, agency costs can adversely affect firm performance (Brown et al., 2011). The out-of-equilibrium model of the relationship between corporate governance and firm performance also suggests that corporate governance has a causal effect on firm performance indirectly through its impacts on the agency conflict of the firm, which is embodied by the incentives and monitoring of the management (Tan, 2009). However, few discussions have been had about the role of agency costs as a mediating variable in the ownership–performance relationship. Such a mediation approach is adopted to examine the relationship between firm performance and government ownership only in Le and Buck (2011). This leaves a large knowledge gap in the literature in terms of the mediated effect of ownership structure on firm performance via agency costs. Therefore, this study primarily attempts to examine the indirect association via agency costs between a set of ownership structures and firm performances.

Agency theory also suggests a link between equity owners and corporate risk-taking. Accordingly, shareholders have different risk preferences, such as risk-averse, risk-neutral and risk-seeking attitudes. For example, it is often argued in corporate governance literature that managers/insiders prefer a lower level of risk in comparison with the owners of a firm; hence they are commonly regarded as risk-averse shareholders (Himmelberg et al., 1999, Downs and Sommer, 1999). It is thus suggested that these differences can determine the types of risk-taking behaviours of equity owners. In addition, corporate risk management theory implies a close association between corporate risk-taking and firm performance under the assumption of ‘high risk–high return’ (Drever et al., 2007). Thus, corporate risk-taking can be considered another potential link between ownership structure and firm performance. Nevertheless, there is limited understanding in the literature about this channel of ownership–performance relationship. Taken together, it can be argued that a new mediation approach that considers both agency costs and corporate risk-taking as mediating variables could be adopted on the basis of agency theory and corporate risk management theory in order to explain the ownership structure–firm performance relationship.

In addition to the mediated associations, endogenously determined associations are potential in the relationship between ownership structure and firm performance. Much empirical evidence has shown that ownership structure and firm performance have a co-deterministic relationship, and they are interrelated (Farooque et al., 2010, Bhagat and Jefferis, 2002, Firth and Rui, 2012). Ownership structure and firm p...