Corporate Governance Practices and Firm Performance of Listed Companies in Sri Lanka
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Corporate Governance Practices and Firm Performance of Listed Companies in Sri Lanka Kumudini Heenetigala Thesis submitted in fulfilment of the requirement of the degree of Doctor of Business Administration Victoria Graduate School Faculty of Business and Law Victoria University Melbourne April 2011 Declaration I, Kumudini Heenetigala, declare that the DBA thesis entitled Corporate Governance Practices and Firm Performance of Listed Companies in Sri Lanka is no more than 65,000 words in length, exclusive of tables, figures, appendices, references and footnotes. This thesis contains no material that has been accepted for the award of any other degree of diploma in any university or institution. To the best of my knowledge, this thesis contains no material previously published or written by another person, except where due reference has been given. ___________________________ __________________ KUMUDINI HEENETIGALA DATE i Acknowledgements This thesis would not have been possible without the support of numerous people, whom I wish to acknowledge. First of all my deepest gratitude to my supervisors Professor Sardar Islam and Professor Anona Armstrong for their dedication, invaluable guidance, scholarly support and commitment of time throughout this process; without this the thesis would not have been a reality. I am also thankful to Professor Anona Armstrong who is my immediate supervisor as the head of Governance Research Program, for inspiring me to complete this thesis and for providing me with unlimited academic support and the opportunity to advance my career in corporate governance. My sincere thanks to Professor Lakshman Watawala and Ceylon Chamber of Commerce for providing me with the necessary information with regards to implementation of the corporate governance code in Sri Lanka, the Colombo Stock Exchange for providing me with access to annual reports, Yong Qiang Li for his advice on statistical analysis and Murray Greenway for his help with formatting. My appreciation goes to my late uncle Dr Neville Gajaweera who encouraged me and gave me moral support to pursue my education in UK, and my late oldest cousin, Jaimi Samaraweera, whose words inspired me to take a further step in my postgraduate studies leading to writing this thesis. I could not have completed this journey without the love and friendship of my family and friends. Thanks to my sisters Lilangani and Thushara, my brother Ravi, my nieces Duleeka, Nuwani and Chukee, my grand nephew William and all my friends. My gratitude to my alma mater, Visakha Vidyalaya; the foundation of this thesis lies in the education I received during the 13 year at this prestigious institution. Finally, this thesis is dedicated to my beloved husband Mahes and my two children Dulani and Damith, for their love, patience and encouragement during this long journey and to my beloved parents Sylvia and Keerthi Amaraweera for their love and guidance throughout my life and for providing me with an excellent education. ii Abstract Introduction: Corporate governance is considered to have significant implications for the growth prospects of an economy. Good corporate governance practices are regarded as important in reducing risk for investors, attracting investment capital and improving the performance of companies. However, the way in which corporate governance is organized differs between countries, depending on their economic, political and social contexts. Purpose: The purpose of this study was to examine the relationship between corporate governance practices and firm performance in Sri Lanka, as a result of the adoption of code of best practice on corporate governance in 2003 and the extent of changes to corporate governance practices four years after (2007). During this period ), the firms that operated in Sri Lanka were affected by political and economic instability. However, the stock market performed well. Critical Literature Review and the Contribution: The theoretical basis for this study was agency theory, which focuses on the separation of ownership and control. Literature in relation to corporate governance practices and firm performance reported mixed results. The conceptual framework underpinning this study described how the board structure and corporate reporting practices of firms in Sri Lanka impacted on firm performance. In this framework corporate governance variables were separate leadership, board composition, board committees and corporate social responsibility (CSR) reporting. Separate leadership refers to the separation of the position of chairman and CEO; board composition refers to a majority of non-executive directors on the board; board committees refers to the presence of audit, remuneration and nomination committees; and corporate social responsibility reporting refers to reporting of CSR activities. Accountability to shareholders and other stakeholders was assessed through corporate reporting practices in relation to corporate social responsibility reporting. The research explored iii the relationship of these variables to firm performance. Firm performance was assessed by Return on equity, Return on assets and Tobin’s Q. This is the first study conducted in Sri Lanka on corporate governance and firm performance during periods of high volatility in the environment due to adverse economic and political conditions. As a result, this study makes a significant contribution to the body of knowledge on corporate governance in developing countries and illustrates how corporate governance impacts on firm performance in unstable environments such as that experienced in Sri Lanka. Methodology: This study is a comparative analysis to gauge the changes to corporate governance practices from 2003 to 2007. A sample of 37 companies was selected from the top 50 listed companies in The Lanka Monthly Digest 50 (LMD) for the years 2003 and 2007. The selection was determined by the availability of data for both years. Data were obtained from annual reports and The Lanka Monthly Digest 50. The data were analysed with SPSS to obtain quantitative measures of descriptive statistics, Spearman’s correlation and analysis of variance. Results, Discussion and Implications: Descriptive statistics from the study showed a significant increase in corporate governance practices between 2003 and 2007 for board composition, board committees and corporate social responsibility reporting. As a result of the increased governance practices in 2007, this study provides evidence in support of a positive relationship for separate leadership, board composition, board committees and firm performance based on return on equity. Both board composition and board committees also had a significant relationship with performance measured by Tobin’s Q in 2007. However, corporate social responsibility reporting practices by the firms in Sri Lanka did not report any relationship to firm performance in 2007. In this study, the positive relationship between corporate governance structures, separate leadership, board composition, board committees and firm performance indicate that firms have implemented corporate governance strategies, which have resulted in higher profitability and share price performance. iv Corporate social responsibility reporting practices in this study did not find evidence of a relationship to performance during the period under study. This may have been due to the fact that CSR was considered a philanthropic act by the markets and not related to business, especially due to the rebuilding activities after the 2004 tsunami. This study supports the agency theory propositions that good corporate governance practices enhance boards’ accountability to shareholders and improve a company’s performance. The lack of relationship between CSR reporting and performance suggests that stakeholder theory is not supported. Conclusion: The conclusions drawn from this study were that even in adverse economic and political conditions, good corporate governance practices were important to the performance of firms operating in Sri Lanka. However, for corporate governance practices to have full impact on firm performance in Sri Lanka, boards should consider CSR strategies that are in the interest of all stakeholders and relevant to the business. v Table of Contents Declaration .................................................................................................... ………..…i Acknowledgements ........................................................................................................ ii Abstract ......................................................................................................................... iii Table of Contents ........................................................................................ ………..…vi List of Tables ................................................................................................................ .x List of Figures ............................................................................................................... xi Acronyms ..................................................................................................................... xii Chapter 1 Introduction ............................................................................................... 1 1.1 Background .............................................................................................................. 1 1.2 Context of the Study ................................................................................................ 2