Corporate Governance On Financial Performance

[Isabella Kells]

Therehas been much research on the relationship between corporate governance and financial performance. Referring to the literature on the role of corporate governance, we can cite the work of Shleifer and Vishny (1997) who consider corporate governance as the set of mechanisms by which capital providers guarantee shareholder profitability. Denis and McConnell (2003) have emphasized the importance of distinguishing between the notion of internal and external mechanisms of governance and their importance for the providers of funds on all points of value creation.

The study of the relationship between governance expressed by the corporate governance score and the improvement of the performance of the latter remains a vast field of study and research that has inspired researchers in the field of accounting, finance, and taxation (Louizi 2007).

The existence of such a relationship has led us to wonder about the factors that can impact this relationship in a direct or indirect way. Considering this fact, we note that managers who behave in a discretionary manner will exert a major influence on the fate of the accounting and tax manipulation of companies and will try to increase their discretionary power.

Within this framework, agency theory has explained this behavior by focusing on the interests of the funders and decision makers in a way that reflects the interest of each party (Jensen and Meckling 1976).

The practices of corporate governance have not stopped evolving. This is presented via the succession of guides to good governance practices that seek to counter the failures detected over time and which manifest themselves at the level of financial scandals, sometimes inducing a harmful imbalance for the global economic fabric. Based on the "FTSE 350 corporate governance review (2013), for the UK, the evolution of good governance guidelines as well as institutions in the field of corporate governance has developed to respond to the panoply of problems that may be directly related to corporate governance.

In the same context, it is important to emphasize that the study of corporate governance must take into account the specificity of each sector of activity since each sector has its own regulations, key success factors, and compliance rules. In our research paper, as our focus is on UK companies, we have chosen to use the 2 digit ICB industry code, which is relevant to the context of our study. In addition, it should be noted that previous research has studied the relationship between corporate governance and financial performance while focusing only on a particular governance mechanism or a particular specificity related to the strengthening of these mechanisms. Again, it must be emphasized that the majority of research studies have examined the relationship between corporate governance and financial performance without giving much importance to the sectoral specificity of the companies studied.

This research paper contributes to the existing literature on several levels. Indeed, it consolidates previous research that tried to show the importance of corporate governance in improving financial performance. Moreover, it focuses on the effect of changes in the business sectors of UK firms so that we can identify the effect of the quality of corporate governance on the performance of firms related to a particular business sector.

This research paper allows us to study the impact of corporate governance on the financial performance sought by shareholders while basing ourselves on the FGLS method, which allowed us to eliminate the various sources of bias identified when using different regressors, namely the generalized least squares method, the regression with the consideration of the presence of the fixed effect as well as the persistence of the autocorrelation problem.

We will try through this research work to emphasize the possible relations between corporate governance and financial performance which is mainly based on the agency theory. It should also be added that the study of the previous relationship by taking into consideration the sectoral characteristics will lead us to turn to the foundations of the institutional theory. The latter theory emphasizes that an institution is constrained by its social, political, economic, legal and technological environment, which it conforms to in order to guarantee its legitimacy and durability.

Corporate governance has always played a fundamental role in monitoring and controlling the proper functioning of business processes transparently. By referring to the various research works, we can see that the agency theory is at the heart of the studies on corporate governance. The work of Ross (1973) and subsequently Jensen and Meckling (1976) has indicated that the agency theory is the most appropriate sphere to study corporate governance.

This theory can lead us to reflect on the way in which managers can behave. We can cite the case of companies that offer their managers variable remuneration depending on the growth of turnover. In the same sense, it must be said that internal control efficiency and internal audit within companies can play an important role in strengthening the governance structure of companies. It represents one of the guarantors of the proper functioning of business processes in a controlled environment to ensure the improvement of financial performance (Nyakundi et al. 2014).

To further develop the role of agency theory in the governance-performance relationship, we can say that agency theory is an analytical framework for understanding the relationships between a firm's stakeholders, including shareholders and management. According to this theory, shareholders have different objectives from those of managers, which can lead to conflicts of interest. Managers seek to maximize their own wealth and power, while shareholders seek to maximize the value of their shares. To align the interests of stakeholders and improve the financial performance of the firm, agency theory advocates the establishment of an effective governance system. Good corporate governance involves putting in place control and oversight mechanisms to ensure that management acts in the best interests of shareholders. This can include the appointment of an independent board of directors, executive compensation linked to company performance, financial transparency and disclosure of relevant information to shareholders. By establishing appropriate incentives and controls, corporate governance can help reduce conflicts of interest and improve the company's financial performance by increasing the value of the company and the return on investment for shareholders. The importance of corporate governance mechanism and its impact on the financial performance was studied by Yermack (1996), en plus Shleifer and Vishny (1997) reviewed the state of corporate governance research using a review of the existing literature. The authors concluded that agency theory is an important framework for understanding the relationship between corporate governance and financial performance, and that it can be used to develop effective governance mechanisms for firms.

Consider a publicly traded company whose shareholders are concerned with maximizing the value of their shares. The company's managers, on the other hand, may have different objectives, such as maximizing their own compensation or maintaining their power within the company. This divergence of interests can lead to strategic decisions that are not optimal for the company or its shareholders. In this case, agency theory suggests that strong corporate governance can help align stakeholder interests and improve the firm's financial performance. For example, the appointment of an independent and competent board of directors can help monitor the activities of executives and make strategic decisions in the interests of shareholders. Similarly, compensating executives based on company performance can provide an incentive to work hard to increase the value of the company.

In summary, agency theory shows that corporate governance is essential for aligning stakeholder interests and improving the financial performance of the firm. By putting in place appropriate control and oversight mechanisms, corporate governance can help reduce conflicts of interest and improve shareholder value.

In studies that have introduced corporate governance as a main variable, two main areas have been examined. The first seeks to address governance from a shareholder and capital structure perspective, the second seeks to address the composition of boards of directors and the improvement of the quality of governance mechanisms to improve financial performance. Among the research that has emphasized the importance of capital structure, we can cite McConnell and Servaes (1990), Nesbitt (1994), Smith (1996), Del Guercio and Hawkins (1999), and Hartzell and Starks (2003), who found that the presence of institutional shareholders positively affects management behavior. Regarding the research that has dealt with the functioning of boards of directors, we can cite Brickley et al. (1994), Lee et al. (1999) who have emphasized the importance of independent or outside directors in improving the level of governance quality. In addition, Jensen (1993) has shown that dual directorships increase the discretion of the director so that the director can influence the financial outcome. For Dechow and Sloan (1991), the introduction of the CEO's age as a variable makes it possible to reflect the difference between executives and their behaviors throughout their career and especially in the last year of service. During the last two decades, institutional theory has contributed greatly to the understanding of the behavioral aspect and the explanation of the reaction of the different stakeholders toward corporate governance (Aguilera and Jackson 2003; Judge et al. 2008). It must be said that this theory has contributed enormously to the study of the interaction between the governance mechanism and the institutional framework in which any firm operates. Several studies tried to examine closely the main characteristics of corporate governance to show if there is a possible explanation of the relationship between corporate governance and fiscal management in a perspective of improving financial performance. While Armstrong et al. (2015) and Seidman and Stomberg (2017) found a significant relationship between the latter two variables, Blaylock (2016) did not find any relationship between these two concepts. Before proposing the research hypothesis of the first chapter, it was necessary to first list the results found by researchers who studied the relationship between corporate governance and financial performance based on the governance index or score.

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