Essay: Corporate governance

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  • Corporate governance
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The world has faced considerable corporate governance issues such as the Enron, World Com and HIH Corporate (Farrar,2008; Du Plessis et al.2011). It is observed that corporate governance is vital for a long term economy and stability of the companies (Ibrahim, Rehman & Roof,2010) since the companies worldwide shows performances of approximately 90% of productivity and also due to the rapid growth occurred during the past years. Considered all these arguments and observations corporate governance is a primary and necessary aspect for the performance of the firms and for the growth of a specific economy as a whole.

By 2016, reports have indicated that Sri Lanka has approximately 1.8 million foreign tourists in the year of 2015 and it further explains that it shows a 17.8% growth over 2014. Studies have identified that Sri Lanka has hotel supply of close to 8,000 rooms mainly based around Colombo and along the South West; however the sector has a total of 28,000 of rooms out of which, 605 falls under the informal sector. Colombo has shown an increase in the hotel supply in 3 and 4 star segments, resulting a slight decline in overall occupancy levels and a decline in average room rates are also being observed. However, the occupancy levels in past three years have shown steady in increase. (Nation,2016)

Defining terms

‘The act of steering, guiding and piloting’describes what boards [should] do when in session. It does not describe and is not a proxy for the board itself, nor any other party or activity outside the boardroom. Regulators (to set rules), proxy advisers (lobbyists on behalf of shareholders and other interests), and shareholder meetings (communications) are all important, but none is corporate governance’ (Crow,2015)

‘Corporate governance system is the combination of mechanisms which ensure that the management (the agent) runs the firm for the benefit of one or several stakeholders (principals). Such stakeholders may cover shareholders, creditors, suppliers, clients, employees and other parties with whom the firm conducts its business. (Goergen and Renneboog,2006) which deals with the conflicts of interests between the providers of finance and the managers; the shareholders and the stakeholders; different types of shareholders (mainly the large shareholder and the minority shareholders); and the prevention or mitigation of these conflicts of interests. (Goergen,2012) and is about ‘the whole set of legal, cultural, and institutional arrangements that determine what public corporations can do, who controls them, how that control is exercised, and how the risks and return from the activities they undertake are allocated.’ (Blair,1995)

In simple terms, corporate governance means the mechanism that controls and directs the firms in their business activities. The corporate governance structure will give specifications for each structure, as an example according to the Sri Lankan best code for corporate governance practice the directors, director’s remuneration, relation with shareholders, accountability and audit, institutional investors, other investors and sustainability reporting. Corporate governance further supports in decision making process in corporate affairs by specifying the relevant rules and procedures that should be followed. Corporate governance helps organizations achieve their goals in a social, regulatory and market environment. Corporate governance can be considered as a mechanism that direct managerial decisions and improve the performance of the firm.

Alternative corporate governance forms are being examined in hospitality industry and the study supports the principle agent perspective and discusses the individual’s drive to join the hotel sector. Studies already done has examined the options of ownership and affiliation of a voluntary chain and the option of integration and franchising. According to this study the aspects such as hostel size, amenities, population and distance from the headquarters may affect the corporate governance practices in hospitality sector. (Boujelbene, Guetat and Jarboui,2015) The different corporate governance practicing systems should be adopted and practiced by the different industries as appropriate to their different needs.

It is evident that organizations are different in hospitality sector when compared to other sectors. (Basak et al.2010) One of the major differences is that the ownership can be involved with real estate ownership and management hence giving more opportunity for conflict of interest. . Eyester, (1988, p.4) states that:

‘As an agent, the operator pays, in the name of the owner, all operating expenses from the cash flow generated from the property, retains management fees and remits the remaining cash flow, if any, to the owner. The owner supplies the lodging property, including any land, building, furniture, fixtures, equipment and working capital, and assumes full legal and financial responsibility for the project’.

This separation of ownership and management may result in agency theory concerning problems: management may focus on customer satisfaction and relationships while owners focus on rather short term goals such as payback and returns.

As the second factor that differentiates the hospitality sector, the characterization of the industry with high capital intensiveness and low level of operating inventory management can be stated. (Defranco and Lattin,2006). Components such as furniture and fixture, equipment, land and building has increased the capital requirements for hotel organizations. This will associate with high level of business risks due to lower level of liquidity and financial inflexibility. Operating inventories are the items that are required to be available at the hotel premises in order to function daily and offer the desired levels of service to their customers.

Third factor would be the unique pressure on the hospitality sector managers due to the pressure of short to long run decisions that are required to be taken. (Reich 1994,p.341) The study states that during short term the production output could be only influenced through modifying the variable inputs such as payroll and staff expenses. However in the long run, production output can be influenced by modifying both the variable and fix inputs.

The fourth factor that distinguish the hospitality sector firms from other industries is that the sensitivity of the industry to the changes in the economy. The firms depend on the unrestricted spending patterns of their customers making the shareholders seek more power to monitor activities of their managers. However, in such a business environment efficient and fast decisions should be taken to tackle the market opportunities hence the shareholders should give proper authority and control to their managers.

Relevant previous knowledge in terms of time line: international vs local

Different countries have adopted the OECD principles, which are the basics for corporate governance practices in order to practice the good corporate governance in their organizations. Good corporate governance means ‘little expropriation of corporate resources by managers or controlling shareholders, which contributes to better allocation of resources and better performance’ (Ali Shah, Butt & Hassan, 2009, p. 625). Moreover, in both developing and developed countries when good corporate governance is practiced it can be used as a balancing role when speeding up the performance of the organizations. Even though there is a basic and worldwide accepted principles for corporate governance countries may have slight changes in adopting those practices due to cultural, economic and social differences. These differences may slightly influence the relationship between the firm performance and corporate governance practices in different countries. (Rashid and Islam,2008). Studies however show that there is a positive relationship between corporate governance and firm performance regardless of the slight changes in adopting corporate governance practices in each country.

A study done by Gooden, Logan and Simon (2013) on corporate governance structure selected by publicly traded lodging and gaming firms are consistent with minimizing monitoring and bonding costs examined in the more complex business models. Study suggested that there is a positive relationship between firms that have the appropriate governance structures and the profitability of the firm. The study also found strong evidence that complex firms had larger board of directors, more outside board members, greater fraction of CEO pay being variable, and more frequent occurrence of CEO/Chairman duality than simple firms, however did not find that there were significant differences in the fraction of insider directors between complex and simple firms. Further analysis of the data has shown when the company is complex and the governance structure is suitable for a less complex firm, it results in significantly low profitability levels, return on assets, and return on equity, and lower – but not significantly lower – valuation based on market-to-book value. The same manner simple firms with corporate governance structure that is more suitable for complex firms has shown lower market-to-book value and significantly lower return on equity and return on assets. A descriptive examination of corporate governance in the hospitality sector (Guilet and Mattila, 2010) which aims to Explore the nature and the extend of corporate governance in the U.S. Hospitality industry shows that hospitality industry firms with weaker shareholder rights was relatively larger in the organization size, have relatively higher earnings per share, higher closing stock prices, return on equity, lower capital expenditure per asset and also higher leverage ratios.

Studies have done to see the impact of ownership structure on the corporate governance of a firm. A research on ownership Structure as a Corporate Governance Mechanism in Slovenian Hotels (Cvelbar and Mihali” 2007) which focuses on analyzing ownership structure and company performance with the consideration of corporate governance theory and the actual privatization process. In the findings, the researcher confirms that state ownership in the hotel sector is significantly higher than in other sectors of the Slovenian economy. Further the research suggests that Slovenian hotel industry needs ownership change, from state-owned and investment funds to more active owners: domestic and foreign companies in order to introduce new ways of governing, develop new strategies and start the internationalization process. The study on impact of state ownership on hotel firm’s characteristics and financial performance in China (Chen, Chen and Kunlun Wu,2013) which studies on the impact of State Ownership on hotel firms’ characteristics and financial performance shows that hotels with high State Ownership in China are small and have high debt leverage and low liquidity. However, State Ownership does not have a strong influence on ROA, ROE and stock return. Petrovic (2010) does a study on the ownership structure as a corporate governance mechanism in Serbian hotels focusing on the ownership structure and company performance considering the corporate governance theory and the actual privatization process. According to the study state-owned and investment funds are operating as important owners of the hotels in a continuous manner. Study findings shows that the financial performance of the organizations is below average when compared to the economy and study suggest that it relates with the ownership structure. Researcher further suggests that such ownership structure has a negative effect on the organizational performance and competitiveness. There are also studies done on the risk taking behavior influenced by the corporate governance practices. Nguyen (2010) has done a research examining the influence of corporate governance on the risk taking Japanese firms considering the idiosyncratic risk and firm performance. The findings suggest that are high idiosyncratic risks are observed in family controlled firms while lower idiosyncratic risks are faced by the bank controlled firms. The study further suggests that Ownership concentration is positively affected with the idiosyncratic risks and Risk taking is associated with specific corporate governance structures. Study further explains that risk taking is stimulated by strong control and alignment of interests. Further studies have been done on the family ownership and corporate governance in the hospitality and tourism industry. A research on the impact of outsider directors and board size on firm performance of family and non-family hotels in Taiwan study examining whether there are significant differences in the relationship between a board of directors and hotel performance and whether this relationship depends on the hotel’s ownership structure. Tsogtbaatar (2014) suggests that significant negative relationship between board size and hotel performance for non-family hotels and insignificant negative relationship between board size and hotel performance for family hotels.

A research on the hospitality industry (Bokpin and Nyarko 2009) is done with the purpose of examining the governance practices of the hospitality industry. The study is done taking evidence from Ghana to ascertain whether the classes of hotels exhibit different or similar governance practices.

An exploratory study on corporate governance practices in Indian Hotel Industry (Venkatachalam and Patwardhan 2011) is done to examine corporate governance reforms being implemented in India and how the hotel industry can benefit from integrating corporate social responsibility. This research suggests that corporate governance is becoming an integral part of the business for large listed hotels.

Jarboui, Guetat and Boujelbene (2015) has done a study on Evaluation of hotels performance and corporate governance mechanisms providing evidence from the Tunisian context with the objective of determining the incidence of internal corporate governance in Tunisian hotels and explain the efficiency of the hotel industry in terms of internal corporate governance. This study has identified that there is a positive correlation between the proportion of independent directors on the board and hotel performance. The hotel performance is viewed as a proxy for director effort and therefore the director’s tenure positively affects the firm’s efficiency and performance.

According to a study done on the governance structure of hotel industry (Rokkan et all.,2009) it is evident that Hotel size, amenities, population and distance to headquarters have influence over the governance structure.

Going further on corporate governance, studies have conducted related to the corporate social responsibility and the hospitality sector. A study on the impact of positive and negat
ive corporate social responsibility activities on company performance in the hospitality industry (Kang, Lee and Chang Huh,2010) that Examines different impacts of positive and negative CSR activities on financial performance of hotels, casinos, restaurants and airlines companies suggests that there is a positive impact of positive CSR on firm value and no significant impact of negative CSR on firm value. However the study does not show any impact of positive or negative CSR on profitability.

Singal (2014) has done a research on corporate social responsibility in the hospitality and tourism industry aiming to explain whether family control and financial condition matter with the objective to see whether the corporate social responsibility activities have an impact on the firm’s financial performance. The results of that study show that strategic investment on CSR has a positive impact on the firm’s financial performance.

Interesting study on investigating the differences in corporate governance between hospitality and non-hospitality firms (Oak and Iyengar,2016) suggests that hospitality ‘rms are more likely to experience agency problems than non-hospitality ‘rms. Hospitality ‘rms have lower governance control mechanisms, better ‘nancial performance and higher-quality earnings than non-hospitality ‘rms. However an understanding of corporate governance control mechanisms helps to reduce agency problems and improves the hospitality ‘rm’s performance in the hospitality corporation.

Existing literature consist with studies that are related to the current research where it discuss the corporate governance influence on the firm performance in different sectors other than hotel sector. The study on the in’uence of governance on tourism ‘rm performance (Yeha and Trejos,2013) that aims to enrich the literature on tourism governance by investigating how board size, the proportion of large shareholders and gender diversity on the Board affect the ‘nancial performance of tourism ‘rms and adds value to existing literature through its findings. The results show that board size is negatively related to performance and that the presence of large shareholders has a signi’cant in’uence on tourism ‘rms’ return on assets and Tobin’s Q. The in’uence of gender diversity on ‘rm performance, however, was inconsistent. These governance variables are also con’rmed as endogenous variables in the tourism sector

Otman (2014) has done a research on Corporate Governance and Firm Performance in listed companies in the United Arab Emirates in order to examine and to understand corporate governance and the effects of corporate governance on firm performance specifically in the Middle East and North Africa (MENA) region, and particularly the United Arab Emirates (UAE). The results of this particular research support the argument that there is a positive relationship between corporate governance and firm performance. In a research done by Bauer et all. (2007) on the topic of the impact of corporate governance on corporate performance using evidence from Japanese firms suggests that Well governed firms significantly outperform poorly governed firms by up to 15% a year. Marn and Romuald (2012) has conducted a similar research in Malaysia on the Impact of Corporate Governance Mechanism and Corporate performance considering the listed companies in Malaysia and the results indicates that both Board Size and Ownership structure variables have a significant effect on firm performance. The study individually focuses on the influence of the board size on the performance of the company, the relationship between the board composition (Proportion of independent non-executive directors in the board) and the performance of company, the influence of audit committee on the performance of the firms, the relationship between the ownership structure (Proportion of non-independent non-executive directors in the board) and the performance of the companies and on the relationship between the CEO status and the company’ performance. Ahmed and Hamdan (2015) researched on the impact of corporate governance on firm performance providing evidence from Bahrain Stock Exchange and that study shows that there is a positive influence of corporate governance mechanisms on performance for the entire firm. Alawneh (2009) also has conducted a research on the relationship between corporate governance and performance of Palestinian firms to investigate the relationship between performance and corporate governance in Palestine and the outcomes indicate that ownership concentration has a good explanatory power of market value change as measured by Tobin’s q. According to the study, it further explains, although not a critical observation that ownership concentration may have a negative impact on the firm value

Goel (2016) has studied the Impact of Corporate Governance Practices on Firm Profitability on selected industries in India to identify the extent of corporate governance practices being followed and reported by Indian companies in different industries and analyze its impact on financial performance. Researcher identifies that there is a significant correlation between total corporate governance score and Tobin Q ratio of market valuation and further states that individual parameters of corporate governance doesn’t have any significant relationship or impact when the market valuation and profitability of the companies are being considered.

A research done in India on the relation between firm level corporate governance and market value (Balasubramanian, Black and Khanna,2010) that tries to explain the relationship between firm level corporate governance and market value indicates that Positive and statistically significant association between Indian Corporate Governance Index and firm market value. The study gives detailed overview of the practices of publicly related firms in India and identifies areas where governance practices are relatively strong or weak.

Darren Henry (2010) in his research of Agency costs, ownership structure and corporate governance compliance examines whether the adoption of specific corporate governance practices is associated with agency cost benefits for companies listed in Australian Securities Exchange. The research findings indicates that adoption of individual corporate governance attributes is found to have no influence on firm level agency costs and greater compliance with an overall governance results in significantly lower agency costs.

Existing literature is rich with topics such as corporate governance on sustainable performance. Study on The impact of corporate governance on sustainability performance (Shrivastavaa and Addas,2013) that examine the relationship between corporate governance and sustainability argue that good and quality corporate governance practices itself can stimulate high sustainability performance and as a result generate improved outcomes. The study has observed that governance disclosure scores have a greater role in the context. It further suggests that Board meetings attendance also has a high impact on the subject. According to the study findings, Boards with a higher percentage of independent directors have a higher disclosure scores and are more likely to have other policies implemented specifically policies like climate change and an environmental supply chain management policy. Such organizations have more tendencies to implement Global Reporting Initiative compliant, have a green building policy along with a social supply chain management.

Identifying gaps

Previous studies also have done research to examine the good corporate governance effect on solving conflicts of interest between shareholders and managers in the operation activities and hence improving performance.

A study has been carried out on Corporate Governance Practices, Issues and Challenges in Sri Lanka (Kalainathan and Vijayarani,2011) that examines the existing corporate governance practices, issues, and challenges in Sri Lanka and the study findings indicate that the concentrated ownership and political influenc
e are the major issues and challenges in the Colombo Stock Exchange. The study suggests that the Colombo Stock Exchange should further improve the existing corporate governance system in order to provide protection to the capital market investors.

The study on Impact of Corporate Governance on Firms’ Dividend Policy providing Evidence from the Listed S&P Sl20 Companies in the Colombo Stock Exchange (Ekanayake, and Paranthaman,2015) which identify the impact of corporate governance on firms’ dividend policy for the listed Standard & Poor’s Sri Lanka 20 companies in the Colombo Stock Exchange found there is a significant impact existing between corporate governance variables and firms’ dividend policy. The study observed that CEO duality has significant positive impact and ownership structure has significant negative impact on the dividend policies of the sampled companies. Negative impact of ownership structure indicate higher potential agency cost as reflected in the firm’s stakeholder structure where the actual agency cost is increased by the weak stakeholder’s dividend payout.

Ajanthan (2013) has conducted a study in Sri Lankan context on the Impact of Corporate Governance Practices on Firm Capital Structure and Profitability to investigate whether there is any relationship among some specific characters of corporate governance, capital structure and profitability of listed Hotels &Restaurant companies. Results shows a positive relationship between ‘Board Size; Board Composition; CEO Duality; ROE; ROA and Debt to Equity Ratio whereas negative relationship between Board Size; and Debt Ratio. In addition to those findings CEO Duality have a positive relationship with Debt Ratio and none of the variables have a significant relationship with capital structure and profitability.

Even though there have been studies done on the corporate governance impact on the performance of other industries and hotel industry including studies carried out in Sri Lankan context, these studies do not give any attention on the star category of those hotels and the size of the hotels.

Summery

Existing literature shows that good corporate governance may result is improved firm performance and increase the ability to access capital which will ultimately result in organizations’ economic development in a sustainable manner, hence corporate governance can be indicated by the satisfaction levels of all the stakeholders of a firm. Evidently the corporate governance considers wide variety of stakeholders of a company including shareholders, managers, employees, customers, suppliers, labor unions, and providers of finance, regulators and the community.

Additional to improving firm performance studies have showed a link between the poor corporate governance practices and increased corruption. These studies further show transparency can be the tool to reduce corruption. (Hirsch,2010) Corporate governance also can be beneficial in auditing process where internal control developments, prevention of frauds and quality and independence of the internal audits are being concerned. This will help to reduce the expectation gaps of the users (Goodwin & Seow, 2002).

Jarboui et all (2014) states that good corporate governance will reduce the inefficiencies due to moral hazards and adverse selection. The different mechanism listed in the corporate governance practices allows firms to carry out internal monitoring enabling the firms to monitor activities and take corrective measures. This will ultimately result in firms achieving the goals. While internal corporate governance facilitates the above the external corporate governance practices will coordinate with control of the organization by the external stakeholders.

It is also stated that strong corporate governance may result in improved environmental reporting (Gibson and O’Donovan,2007) Supporting this arguments, other studies state that corporate governance structure is related to environmental and social aspects that the stakeholders may consider in taking key corporate decisions. (Admas and Zutshi,2004).) When considering all the studies it is evident that there is a significant relationship between corporate governance and firm valuation and that good governance will result is high firm valuation in the market

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