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IJMF
6,3 The efficacy of principle-based
corporate governance practices
and firm financial performance
190
An empirical investigation
Krishna Reddy, Stuart Locke and Frank Scrimgeour
University of Waikato, Hamilton, New Zealand

Abstract
Purpose – This paper seeks to address the effect that principle-based corporate governance practices
have on the financial performance of large publicly-listed companies. In 2004, the New Zealand Securities
Commission (NZSC) promulgated nine high level principles and guidelines for all business entities with
an aim of improving corporate governance practices and boosting investor confidence in the New
Zealand capital market. This event provides a point for empirically testing companies’ responses.
Design/methodology/approach – Panel data for the NZX top 50 companies over the period 1999-2007
are analysed using ordinary least squares (OLS) and two stage least squares (2SLS) regression techniques
to evaluate whether: those firms that were continuously compliant with the NZSC requirements perform
better; and the firm performance post-NZSC recommendations is better than pre-NZSC recommendations.
Tobin’s Q, market-to-book (MB) and return on assets (ROA) metrics are used as dependent variables..
Findings – The findings indicate that large listed companies have universally adopted the Securities
Commission recommendations, establishing subcommittees for audit and remuneration, and having a
majority of non-executive/independent directors on the board which, on average, have seven members.
There is support for the view that the NZSC recommendations have had positive influence on firm
performance measured by Tobin’s Q, MB and ROA. The results show that the presence of a
remuneration committee has had a positive influence on firm performance.
Research limitations/implications – This study provides empirical support for the corporate
governance recommendations made by the NZSC in 2004, giving support to the principle-based
corporate governance practices to be adopted in New Zealand. The sequential testing of each NZSC
recommendation provides a comprehensive picture of performance outcomes which has not been
achieved in prior research. The interdependency issues are of interest and the correlation between
recommendations provides useful insights.
Originality/value – This study offers insights for policy makers interested in adopting
principle-based corporate governance practices within their country. Within New Zealand, public
policy developments and stock exchange listing requirements/regulatory issues with associated
compliance burdens are better informed as a consequence of the research.
Keywords Corporate governance, Boards of directors, Corporate ownership, Financial performance,
New Zealand
Paper type Research paper

1. Introduction
This study addresses the question whether principle based-corporate governance
practices have a positive impact on financial performance of large listed companies in
International Journal of Managerial New Zealand. There are theoretical reasons to assume that improved governance
Finance
Vol. 6 No. 3, 2010 practices will lead to better financial performance through:
pp. 190-219
q Emerald Group Publishing Limited .
an increase expected cash flows accruing to the investors; and
1743-9132
DOI 10.1108/17439131011056224 .
a reduction in the cost of capital.
Shareholders believe that with improved governance practices more of the firm’s free Principle-based
cash flow will be returned to them as dividends rather than being expropriated by the corporate
managers who control the firm ( Jensen, 1986; La Porta et al., 2002; Shleifer and
Wolfenzon, 2002). Empirical studies support the view that improved governance governance
practices lead to better firm financial performance (MacAvoy and Millstein, 2003;
Millstein and MacAvoy, 1998). Studies using data from large economies show that
better-governed firms reduce control rights, which stockholders and creditors confer 191
on managers, increasing the probability that managers invest in shareholder value
creating projects (Shleifer and Vishny, 1997)
Consistent with this perspective regulators and governance advocates, after the
failure of high profile companies such as Adelphia, Enron, Parmalat, Tyco and
WorldCom, considered ways in which corporate governance practices could be
improved. In New Zealand, the debate focused primarily on whether to adopt a flexible
principle-based governance approach[1] compared to a “one size fits all” rule-based
approach that was adopted by the USA namely Sarbanes-Oxley Act, 2002. New
Zealand adopted a principle-based approach similar to the UK, Canada and Australia
with the view this will minimise the compliance costs. Several empirical studies in the
USA investigate the effect that a rule-based governance model has on firm
performance. However, investigations focusing on the principle-based model are
relatively scarce. This study, by reporting the findings of empirical tests in a
principle-based environment and contrasting these with those previously conducted in
the US rule-based environment, makes an important contribution to understanding
corporate governance in a global context.
New Zealand is a particularly interesting case to analyse for a number of reasons.
First, the passage of the Companies Act 1993, the Financial Reporting Act 1993 and
related legislation made it mandatory for publicly listed companies to report
governance related information in their annual reports. An increase in reported cases of
poor financial performances has been associated with poor governance practices in
many sectors of the New Zealand economy. Sufficient time has now passed since the
implementation of the revised governance practices in 2003 to make it possible to study
whether they had any effect on the financial performance of listed companies in New
Zealand. Is the corporate governance principles adopted in New Zealand are similar to
those implemented in other overseas jurisdictions it is possible in further research to
make international comparisons.
Although New Zealand did not suffer scandals to the extent reported in larger
economies, such as the USA, UK and Australia, concern with poor performance (Healy,
2003) and sub-standard governance practices were highlighted by both local and
international market participants (Godfrey and Horsely, 2003). The failures and
sub-standard corporate governance practices signal that urgent attention is required
from the policy makers should New Zealand wish to maintain integrity in the capital
market.
To harmonise corporate governance practices with trading partners and to boost
investor confidence, the New Zealand Securities Commission (NZSC), in 2004,
promulgated nine high level principles and guidelines that are intended to contribute to
high standards of corporate governance in New Zealand entities. The aim is to increase
shareholder confidence in the governance processes. The three key elements of the
NZSC’s principles and guidelines that are also found in the corporate governance rules
IJMF and codes in the USA, the UK, Canada and Australia include: independence of chair,
6,3 non-executive/independent director, and board committees. It is assumed that the
adoption of such international best practices will lead to an improvement in the
corporate governance practices in New Zealand listed companies. Although the NZSC
recommendations are not mandatory, all companies listed on the stock exchange in
(NZX) are required to observe NZSC guidelines to the fullest extent effective from 29
192 October 2003[2]. The companies reporting on corporate governance practices are
required to cover all the recommended principles, and departures from these must be
explained to the shareholders (NZSC, 2004).
This study extends the current literature on the corporate governance practices,
examining the efficacy of the corporate governance practices recommended by the
NZSC (soft regulation) on large listed companies’ financial performance. This adds to
the understanding of the workings of the underlying mechanisms of so-called “soft
regulations” and its effect on financial performance. The results will also contribute to
understanding of how good governance mechanisms work in the global economy. The
comparative analysis of findings from a principle based framework with the findings
of the studies conducted under the US rule-based model will contribute a more
fundamental understanding of the governance-financial performance nexus. The
ensuing discussion of the effects that the rule-based versus principle-based model have
on financial performance from an international perspective, including the effect (if any)
of international financial reporting standards (IFRS) will have on such practices in the
future, contributes significantly to understanding how governance contributes to
value.
The next section reviews prior research and is followed by a description of the
methods and procedures used for this empirical study. The results and conclusions
then follow.

2. Literature review
Agency problems arising from the separation of ownership and control are studied by
a long tradition of scholars from Smith (1776), Berle and Means (1932), Jensen and
Meckling (1976), Fama and Jensen (1983) and Shleifer and Vishny (1997) among others.
They postulate that the diffuse ownership structure provides incentives for managers
to expropriate firms’ assets in a manner that adversely affects shareholder wealth. The
corporate governance literature identifies a variety of mechanisms that are available to
the shareholders to ensure managers act in the best interest of the shareholders. These
mechanisms are classified as both internal, such as ownership by managers and the
board, independence of the board, size of the board and the establishment of the board
committees and external, such as block ownership, the level of debt financing, the
market for corporate control, and product market competition (Barnhart and
Rosenstein, 1998; Denis, 2001). However, most of the studies on corporate governance
concentrate mainly on a specific aspect of governance, such as insider ownership
(Mehran, 1995), blockholding (Demsetz and Lehn, 1985; McConnell and Servaes, 1990;
Mikkelson and Ruback, 1985); board composition (Bhagat and Black, 2002; Denis and
Sarin, 1997; Hossain et al., 2001), and leverage (Agrawal and Knoeber, 1996; Begley and
Feltham, 1999). The study uses an extensive set of governance variables which provide
comprehensive picture of the company and industry level governance practices and the
mechanisms that have been recommended internationally to improve governance
practices. The study includes three additional control variables, that is, audit Principle-based
committee, remuneration committee and dividends. corporate
A problem of endogeneity, which plagued many previous corporate governance
studies (Himmelberg et al., 1999; Holderness et al., 1999; McConnell and Servaes, 1990; governance
Morck et al., 1988), will also be addressed in this paper. Himmelberg et al. (1999) and
Palia (2001) argue that endogeneity in the performance-ownership relationship may
have been caused by omitted variables that have a potential to affect both performance 193
and ownership, thus leading to spurious relationships. Himmelberg et al. (1999)
suggests that the unobserved level of intangible assets induces a positive correlation
between managerial ownership and performance (Tobin’s Q). Firms with a high
proportion of unobserved intangible assets will require a higher level of managerial
ownership to align interests. At the same time, they will also have a higher Tobin’s Q
value because the market will value intangibles while the book value of assets (in the
denominator of Tobin’s Q) will understate the value of intangibles.
The quality of monitoring technology is another unobserved variable that has the
potential to affect both, the level of insider ownership and firm value. Those firms that
have superior monitoring technology may need lower levels of insider ownership to
align incentives resulting in and have higher firm value because fewer resources will
be diverted to managerial perquisites.

2.1 Ownership structure

The interest alignment hypothesis posits that equity ownership by insiders (officers
and directors) will better align managers’ goals with shareholders’ goals (see Berle and
Means, 1932; Jensen and Meckling, 1976). As the managers’ proportion of equity
ownership increases, their interests coincide more closely with those of outside
shareholders, reducing the agency problems and improving firm financial
performance. Demsetz (1983) argues that firm performance will only increase if the
ownership structure is in disequilibrium. Some studies find a positive relationship
between an out-of-equilibrium level of insider equity ownership and firm performance.
For example, Mehran (1995) examines the executive compensation structure of 153
randomly-selected manufacturing firms and reports that firm performance (measured
as Tobin’s Q and ROA) is positively related to the percentage of equity held by
managers as well as to the percentage of their compensation that is equity-based.
From a corporate governance perspective, managerial ownership is a new concept
for New Zealand; however, the trend to issuing warrants and shares to senior staff is
growing. The evidence available (Elayan et al., 2003; Hossain et al., 2001; Reddy et al.,
2008a) supports the view that the proportion of managerial ownership in New Zealand
companies is still less than optimal. Therefore, it is assumed that any increase in
managerial ownership is likely to have a positive effect on financial performance.
Therefore,the first hypothesis is:
H1a. Insider ownership is positively associated with a company’s financial
performance.
A shareholding of 5 percent or more of a company’s stock is considered to be a
significant constituting a blockholding (Denis, 2001; NZSC, 2006). Such blockholders
may be individuals, corporations, or institutional investors. Shleifer and Vishny (1986)
provide support for the view that block holdings are important elements for controlling
IJMF agency cost. The average block ownership of 76.3 percent in New Zealand firms
6,3 (Hossain et al., 2001) is consistent with New Zealand’s weak minority shareholder
rights. Also, the existence of weak regulations regarding shareholder rights allows
initial owners to continue to hold large blocks of shares in companies after going
public. Since blockowners hold undiversified large stakes it is argued, consistent with
the interest alignment hypothesis that the blockholders will provide a similar level of
194 vigilance as if they owned the company themselves. Blockholding also solves the
free-riding problem making manager monitoring easier (Agrawal and Mandelker,
1990; Hill and Snell, 1988, Hill and Snell, 1989; Shleifer and Vishny, 1986). Since
blockholding is an important feature of the company ownership structure in New
Zealand, it is assumed that the presence of blockholders will have a positive effect on
firm financial performance.
Thus the second hypothesis is:
H1b. Blockholders will be positively associated with a company’s financial
performance.

2.2 Board structure

The NZSC (2004) recommends that the boards of New Zealand publicly-listed
companies should have an independent chair, the majority of members should be
non-executive directors and a minimum of one third of the members should be
independent directors[3]. However, the debate in the corporate governance literature
continues as to whether an increased participation of outside directors on the board
leads to an improvement in the business’ financial performance.
Hence the third hypothesis is:
H2a. The proportion of non-executive/independent directors is positively
associated with the company’s financial performance.
There is no one optimal “size” for a board. However, organisational behaviour research
suggests that as group sizes grow larger, total productivity exhibits diminishing
returns (Hackman, 1990). Consistent with this view, Jensen (1983) suggests that a board
should have a maximum of seven or eight members to function effectively. In
Australia, the boards of the 250 largest companies have on average 6.89 members
(Psaros, 2009). From an agency perspective, smaller boards are more likely to reach
consensus and also allow members to engage in genuine debate and interaction
(Firstenberg and Malkiel, 1994). Alternatively, larger boards tend to provide an
increased pool of expertise, greater management oversight, access to wider range of
contracts and resources (Goostein et al., 1994; Psaros, 2009). However, Forbes and
Milliken (1999), Yawson (2006), Pye (2000), and Mak and Kusnadi (2005) argue that
larger boards suffer from higher agency problems because it is difficult to coordinate
and have difficulty making value maximising strategic decisions.
In New Zealand there is only a small pool of directors available from which
companies may choose and may be difficult to obtain the right balance in terms of
skills, expertise and environmental linkages required in the board room with a smaller
board size. It is argued that to balance skills required in the board room, New Zealand
companies may require a larger board size than might otherwise be the case in larger
economies. Therefore, it is assumed that board size will have a positive effect on firm
financial performances.
 In line with the prior literature the fourth hypothesis is: Principle-based
H2b. Board size is positively associated with a company’s financial performance. corporate
governance
2.3 Use of debt and dividend policy
Previous studies provide both theoretical and empirical support that use of both debt
and dividend helps to discourage overinvestment of free cash flow by self-serving
managers. Debt acts as a corporate governance mechanism that can voluntarily be used 195
to transfer the functions of monitoring and evaluating managerial performance to the
participants of the capital market (debtholders) (Agrawal and Knoeber, 1996; Begley and
Feltham, 1999; Jensen, 1986). Conversely, Agrawal and Knoeber (1996) and Beiner et al.
(2003) find that there is no relationship between debt and firm performance. Fama (1980)
states that when managers are less diversified than their shareholders’ i.e. in addition to
holding stock and stock options, their human capital is also specific to the firm.
Consequently, the managers may increase leverage beyond the “optimal capital
structure” to increase the voting power of their equity stakes and reduce the likelihood of
a takeover and the resulting possible loss of job tenure. In New Zealand companies have
relied on debt as a source of capital and debtholders have a tendency to safeguard their
investment, monitoring firm performance on a regular basis. It is assumed that the use of
debt will have a positive effect on firm financial performance.
Similarly, companies may set a target ratio of dividend to earnings as a control
instrument similar to debt financing. The higher the payout ratio, the smaller the
amount of free cash flows. Also, Crutchley and Hansen (1989) show evidence of
dividend policy acting as a corporate monitoring vehicle. Farinha (2003) provides
empirical evidence of dividend policy reducing agency problems either by increasing
the frequency of external capital raising and associated monitoring by investment
bankers and investors (Easterbrook, 1984) or it is reasonable to assume that dividend
payouts will have a positive effect on company performance.
Basing on the literature it is assumed that the use of both debt and dividend will
lead to improved firm performance.
Therefore, the fifth and sixth hypotheses are:
H3a. Debt will be positively associated with a company’s financial performances.
H3b. Dividend payouts will be positively associated with a company’s financial
performance.

2.4 Board committees

Empirical research provide support that the presence of an audit committee is
associated with fewer financial reporting problems (McMullen, 1996). Klein (2002)
shows that independent audit committees reduce the likelihood of earnings
management thus improving transparency.
On the other hand, both Main and Johnston (1998) and Weir and Laing (2000) reported
that the existence of a remuneration committee has positive effect on performance. Klein
(1998) finds evidence of a positive relationship between the presence of a remuneration
committee and performance but notices this relationship is not highly significant.
Despite the NZSC recommendations and guidelines to incorporate board
committees, very few studies, to date, focus on their relationship with firm financial
performance. Dalton et al. (1998) provide a similar view that relatively little research
IJMF has been undertaken in the relationship between board sub committees and
6,3 performance. However, the international evidence suggests that it is likely that
empirical research in New Zealand will find a positive link between board
sub-committees and company performances.
The seventh and eighth hypotheses are:
H4a. The presence of an Audit Committee will be positively associated with a
196 company’s financial performance.
H4b. The presence of a Remuneration Committee will be positively associated
with a company’s financial performance.

3. Methodology and procedure of analysis

Several studies look at the effect that corporate governance practices have on financial
performance measured by Tobin’s Q. However, these studies do not account for the
possible interrelationships among different control mechanisms resulting from
endogeneity issues (Beiner et al., 2004). Also, these studies’ do not include mechanisms
such as board sub-committees (audit and remuneration) and dividends, which if
included may influence the results. Therefore, this study broadens the scope of
previous investigations by including a wider set of mechanisms, controlling for the
problem of endogeneity and the issue of whether compliance with NZSC
recommendations leads to an improved performance.

3.1 Data and data sources

Data for this study are obtained from NZX Deep Archive for the top 50 publicly-listed
companies on the NZX for the period 1999 through 2007. The top 50 companies are
chosen because they constitute the NZX50 index and the findings of this study will be
more readily comparable to international studies of the larger company sector in
respective countries. It is to be noted that the NZX50 was introduced in New Zealand
on 3 March, 2003, and prior to this date, the top 40 companies are used to determine the
NZX40 index. Therefore, the sampling period 1999 to 2002 uses top 40 firms in each
year, and the years 2003 to 2007 includes top 50 companies in each year. In total, there
are 410 firms included in the sample covering all sectors of the economy, including
primary, energy, goods, property, service and investments. A total of 70 firms are
excluded from the sample because they did not have all the information while the
remaining 340 firms (78.3 per cent of the sample) have all the information and are
included in the pooled data set for this study.

3.2 Dependent variables

Tobin’s Q as the performance measure is commonly used as a dependent variable
(Agrawal and Knoeber, 1996; Chung and Pruitt, 1994; Hossain et al., 2001; Kang and
Stulz, 1996; Loderer and Peyer, 2002; Perfect and Wiles, 1994; Reddy et al., 2008a). An
accounting-based performance measure return on assets (ROA) has been used by
Demsetz and Villalonga (2001), Finch and Shivadasani (2006), Thomsen et al. (2006).
Demsetz and Villalonga (2001) argue that both performance measures have pitfalls. For
example, futuristic and forward-looking measure Tobin’s Q is typically estimated as:
 MVE þ L = T Debt þ Net S = T Debt Principle-based
Tobin’s Q ¼
Total Assets corporate
Where MVE (the market value estimate) is the product of a firm’s share price and the governance
common stock outstanding, L/T Debt is the book value of long term liabilities; Net S/T
Debt is the book value of current liabilities less current assets. Demsetz and Villalonga
(2001) argue that although the numerator of Tobin’s Q partly reflects the value that 197
investors assign to a company’s intangible assets, the denominator does not include the
investment the company has in intangible assets, such as, advertisement and research
and development. These items are simply treated as expenses. This distorts the
performance comparison of firms that rely on the differing degrees of intangible capital
(see Demsetz, 1979; Telser, 1969; Weiss, 1969). To overcome this problem recent studies
use depreciated book value of tangible assets. Tobin’s Q is estimated in the same way
for this study as well.
The accounting-based performance measure return of assets (ROA) is also used in
this study. The accounting-based profit measure is criticised as being
backward-looking and it only partially estimates future events in the form of
depreciation and amortization. On the other hand, Tobin’s Q is greatly influenced by a
wide range of unstable factors, such as, investor psychology, and market forecasts.
Considering the above concerns, both measures of performance are used in this study.
The ratio of market value to book value of assets (MB) is also used in this research:
Stock Price*No: of Shares
MB ¼
Total Equity ðTEÞ
where TE is equal to net assets, that is, assets less debt (TE ¼ A 2 L).

3.3 Independent variables

The independent and control variables employed in this study are factors identified in
prior research as influences performance, either positively or negatively. The variables
and the way in which they are determined in this study are:
.
Insider ownership (IOWN) is the proportion of shares held by all members of the
board of directors divided by total ordinary shares outstanding.
.
Blockholding (BOWN) is the proportion of shares held by the 20 largest
shareholders of the company.
.
Non-executive/independent directors (NED) is the proportion of the
non-executive/independent directors on the board.
.
The board size (BDS) is the natural log of the total number of directors on the
board.
.
Leverage (LEV) is the proportion of the debt defined as long term liabilities plus
short-term liabilities divided by the total assets.
.
Firm size (Log (TA)) is the natural log of total assets which is a proxy for size.
.
Dividend (DIV2TA) is the dollar amount of the dividend paid by the company
divided by book value of the total assets.
. To study the effect these committees have on firms’ financial performance, two
dummy variables are created. The Audit Committee (ACOM) is the dummy
IJMF variable set equal to 1 if companies have an audit committee; otherwise it is set
6,3 equal to 0. A Remuneration committee (RCOM) is the dummy variable set equal
to 1 if companies have a remuneration committee; otherwise it is set equal to 0.
.
Firm level risk (FMRISK) is the standard deviation of the daily stock price of the
firm for the period 1999 through to 2007.
.
The firm business risk (BUSRISK) is the standard deviation of the five year
198 return on assets.
.
To study the effect of the timing of NZSC recommendations on the company
performance, a dummy variable AFTER2003 is created. AFTER2003 is equal to
1 if the year is after 2003; otherwise it is set equal to 0.
.
A dummy variable COMPLIED measure the effect NZSC recommendations has
on the performance of companies that continuously were in compliance with the
NZSC recommendations during the sampling period. COMPLIED is equal to 1 if
company complies with the NZSC recommendations (that is, has non-executive
directors, audit committee and remuneration committee); otherwise equal to 0.
.
To study the effect of compliance with NZSC recommendations on company
performance after 2004 is captured by the variable ComAft, which is determined
by multiplying COMPLY by AFTER2003.
.
To study the effect growth of the New Zealand economy had on companies’
financial performance a variable RGDP is created. RGDP is the yearly real
growth rate.

In practice, each firm has different corporate governance structures and those
structures are assumed to be similar for companies that are in the same industry.
Previous studies have looked at the industry effect on companies’ performance. To
study the effect corporate governance practices have on performance industry dummy
variables are created. NZX classifies all listed companies into seven sectors, namely,
primary (agriculture and fishing, mining, forestry, and building), energy, goods (food,
textile and apparel, intermediate and durables), property, service (transport, port,
leisure and tourism, media and communication, finance and other services), investment
and overseas. Using NZX classification, seven industry dummy variables are
introduced. IND1 is the dummy variable equal to 1 if the company belongs to primary
industry, otherwise equal to 0. IND2 is the dummy variable equal to 1 if the company
belongs to energy industry, otherwise equal to 0. IND3 is the dummy variable equal to
1 if the company belongs to goods industry, otherwise equal to 0. IND4 is the dummy
variable equal to 1 if the company belongs to property industry, otherwise equal to 0.
IND5 is the dummy variable equal to 1 if the company belongs to service industry,
otherwise equal to 0. IND6 is the dummy variable equal to 1 if the company belongs to
investment industries, otherwise equal to 0. IND7 is the dummy variable equal to 1 if
the company belongs to overseas, otherwise equal to 0.
There are a number of companies that were in the NZX Top40 list in 1999 that are
not in NZX Top50 list in 2007 raising concerns regarding the effect that non-surviving
firms have on the results. To control the effect of non-survivorship firms on the results,
a dumpy variable SURV is created which is equal to 1 if the firm is continuously
present in all the years of the sampling period from 1999 to 2007, otherwise it is equal
to 0. The variable CSURV measures the effect firms that survived through the
sampling period and also complied with NZSC recommendations on firm performance. Principle-based
It is calculated by multiplying COMPLIED by SURV.
corporate
3.4 Model specification governance
Most of the literature uses univariate or multivariate regression analysis to test the
relationship between corporate governance factors and firm financial performance.
These studies consider ownership as an exogenous variable. Based on these prior 199
studies an ordinary least squares regression (OLS), allowing ownership to have a
simple linear relationship to establish if governance and control mechanisms have an
effect on firm performance is employed. The models estimated are:
FP ¼ a1 þ b11 IOWN þ b12 BOWN þ b13 NED þ b14 BDS þ b15 LEV

þ b16 DIV2TA þ b17 logðTAÞ þ b18 ACOM þ b19 RCOM þ b20 FMRISK

þ b21 BUSRISK þ b22 SURV þ b23 RDGP þ b24 IND1 þ b25 IND2

þ b26 IND3 þ b27 IND4 þ b28 IND5 þ b29 IND6 þ b30 IND7 þ e ð1Þ

FP ¼ a2 þ b21 IOWN þ b22 BOWN þ b23 NED þ b24 BDS þ b25 LEV

þ b26 DIV2TA þ b27 logðTAÞ þ b28 ACOM þ b29 RCOM þ b30 FMRISK

þ b31 BUSRISK þ b32 ComAft þ b33 SURV þ b34 RDGP þ b35 IND1

þ b36 IND2 þ b37 IND3 þ b38 IND4 þ b39 IND5 þ b40 IND6 þ b41 IND7 þ e ð2Þ

FP ¼ a3 þ b31 IOWN þ b32 LESS1 þ b33 BET510 þ b34 BET1020 þ b35 OVER20

þ b36 BOWN þ b37 NED þ b38 BDS þ b39 LEV þ b40 DIV2TA

þ b41 logðTAÞ þ b42 ACOM þ b43 RCOM þ b44 FMRISK þ b45 BUSRISK

þ b46 ComAFT þ b47 CSURV þ b48 IND1 þ b49 IND2 þ b50 IND3

þ b51 IND4 þ b52 IND5 þ b53 IND6 þ b54 IND7 þ e ð3Þ

where FP ¼ Firm Performance measured by Tobin’s Q, MB and ROA.
Equation (1) determines the relationship between performance and governance
mechanisms of firms that were continuously noncompliant with NZSC recommendations
since 1999. This is undertaken for the three firm performance measures. Equation (2)
determines the relationship between performance and governance mechanisms for firms
that complied with the NZSC recommendations after 2003. Also determines the effect of
survivorship on performance. The analyses are undertaken for three performance
measures. Equation (3) estimates whether a piecewise linear relationship exists between
insider ownership and firm performance. This is undertaken for IOWN less than 1
percent, between 1 percent and 5 percent, between 5 percent and 10 percent, between 10
IJMF percent and 20 percent and over 20 percent. Dummy variable LESS1 is equal to 1 if
IOWN is less than 1 otherwise equal to 0. Dummy variable BET15 is equal to 1 if IOWN
6,3 is less than 1 otherwise equal to 0. Dummy variable BET510 is equal to 1 if IOWN is less
than 1 otherwise equal to 0. Dummy variable BET1020 is equal to 1 if IOWN is less than
1 otherwise equal to 0. Dummy variable OVER20 is equal to 1 if IOWN is less than 1
otherwise equal to 0.
200 To study whether the firms that complied with NZSC recommendations after 2003
improved performance compared to the period before 2003, a performance measure
FPdiffAV is created. FPdiffAV is the difference between average firm performance for
the period 2004-2007 and 1999-2003:
FPdiffAV ¼ a3 þ b31 IOWN þ b32 BOWN þ b33 NED þ b34 BDS þ b35 LEV

þ b36 DIV2TA þ b37 logðTAÞ þ b38 ACOM þ b39 RCOM

þ b40 FMRISK þ b41 BUSRISK þ b42 CSURV þ e: ð4Þ

4. Empirical results
4.1 Descriptive statistics
Table I provides a summary of the sample descriptive statistics for the pooled data.
The mean Tobin’s Q ratio is 3.26, with a median of 1.83. A Tobin’s Q ratio greater than
one is favourable, indicating the firm did create value for shareholders. The mean MB
is 0.50 and median is 0.45 indicating that market value of firms’ shares is 50 percent
less than the book value of the firms’ equity. The mean of ROA ratio is 0.07 with a
median of 0.06 indicating that large firms on average have positive performance. The
mean proportion of managerial ownership (IOWN) is 12 per cent but the median is only
1 per cent. The 25th percentile is 0 per cent and 75th percentile is 16 per cent. Hossain
et al. (2001) study 633 firms of different sizes and report mean (median) managerial
ownership for the period 1991/1997 of 6.8 per cent (0.6 per cent) and lower and upper
quartiles of 0.1 per cent and 5 per cent respectively. These indicate that managerial
ownership in large firms is slightly higher in New Zealand. According to Hembry
(2008), the trend is growing as more firms are linking managerial remuneration with
the firm’s performance.
The mean (median) proportion of stock held by the 20 largest shareholders (BOWN)
is 63 per cent (65 per cent). The inter-quartile range for BOWN is 48 per cent-78 per
cent. Hossain et al. report a mean (median) BOWN of 76.3 per cent (78.3 per cent) and
inter-quartile range of 68.7 per cent-87.3 per cent. Chen et al. (2008) report that 60 per
cent of stocks are held by five largest shareholders which are institutions. Although
block ownership in New Zealand has declined from an average of 76.3 per cent during
1991/1997 period to 63 per cent in 1999/2007, it is still relatively high. A comparison to
economies with similar financial systems where the fraction of shares held by the
non-controlling shareholder is 80 per cent and 90 per cent for the top 20 US and UK
firms, respectively (Kapopoulas and Lazaretou, 2007), New Zealand is very low. This
indicates that New Zealand needs strong protection of minority shareholder rights to
safeguard their interest which may in turn increase liquidity in the stock market
(Healey, 2003). In summary, there is evidence that large New Zealand firms
increasingly use incentive-based mechanisms (such stock ownership) to motivate
 Principle-based
Variable Mean Median Min. Max. Inter-quartile range
corporate
Q-ratio 3.26 1.83 2 0.21 40.48 1.09-3.78 governance
MB 0.50 0.45 0.02 1.43 0.33-0.64
ROA 2.84 1.85 0.05 25.62 1.12-3.34
IOWN 0.12 0.01 0.00 1.000 0.00-0.16
BOWN 0.62 0.65 0.05 0.95 0.47-0.77 201
NED 0.76 0.80 0.0 1.00 0.64-0.88
BDS 6.98 7.00 3 13 6-8
ACOM 0.96 1.00 0 1
RCOM 0.78 1.00 0 1
LEV 0.47 0.44 2 2.04 0.98 0.32-0.63
DIV2TA 0.06 0.04 0.000 1.00 0.02-0.06
Log(TA) 5.85 5.75 4.44 8.59 5.26-6.29
FMRISK 0.68 0.35 0.02 5.21 0.18-0.79
BUSRISK 0.92 0.48 0 6.746 0.19-1.15
Notes: This table presents the descriptive statistics for the dependent and independent variables. The
measurement of each variable is explained given as follows: Q ratio is Tobin’s Q approximated by
taking the sum of the market value of common equity, book value of long term liabilities, book value of
net short term debt divided by the net fixed assets. MB is the market to book value of shareholders’
equity. ROA is the net income dived by book value of total assets. IOWN is the proportion shares held
by all members of the board of directors, including top officers of the firm who are members of the
board to total shares outstanding. BOWN is the proportion of shares held by 20 largest shareholders of
the firm. NED is the number of independent non-executive directors. BDS is the size of the board of
directors. ACOM is dummy variable set equal to 1 if companies have an audit committee, otherwise it
is set equal to 0. RCOM is dummy variable set equal to 1 if companies have remuneration committee,
otherwise it is set equal to 0. LEV is the proportion of the debt defined as long term liabilities plus short Table I.
term liabilities divided by the total assets. DIV2TA is the dividend divided by book value of the total Pooled cross-section
assets. Log (TA) is the log of total assets is proxy for size. FMRISK is the standard deviation of the time-series sample
daily stock price of the firm’s stock for each year from 1999 to 2007. BUSRISK is the standard descriptive statistics for
deviation of the five year return on assets selected variables

managers and directors and therefore, manage agency conflicts. Since BOWN is
relatively high, this suggests IOWN is not a strong mechanism itself to deal with
agency problems in large firms in New Zealand.
The mean (median) proportion of non-executive/independent directors is 76 per cent
(80 per cent) with an inter-quartile range of 64 per cent-88 per cent. The typical
(median) board has seven directors with a fairly narrow inter-quartile range of six to
eight which is similar to Fox (1996) who notes that board size declined in New Zealand
from seven members in 1970 to six members in 1983. The median
non-executive/independent directors and size of the board remains relatively
constant through the periods 1991/1997 and 1999/2007. This indicates that the size
of boards, of large companies in New Zealand is appropriate for its size and the role it
plays in terms of managing agency conflict.
On average, 96 per cent of the firms have an Audit Committee and 78 per cent have a
Remuneration Committee. A high percentage of the large companies have board
committees recognising the important role they play in mitigating agency conflict.
This is supported by the fact that the NZSC recommendations regarding board
committees came into effect after 2003, the results show that large companies have had
IJMF board committees since 1999. In 1999, (on average) 86 per cent of the companies in the
6,3 sample had audit committees and 64 per cent had remuneration committees. In 2006, 95
per cent of the companies had audit committee and 91 per cent have remuneration
committees.
The mean (median) dividend to total assets is 6 per cent (4 per cent) and
inter-quartile range of 2 per cent-6 per cent, indicating that dividend payout is not high
202 in large companies. This may be attributable to the fact that these larger companies are
not making a high profit and/or the small nature of New Zealand capital market makes
it difficult to raise capital. Accordingly, profit is usually retained for future investment
purposes. The mean (median) leverage is 47 per cent (44 per cent). The leverage
increased from 40.5 per cent in 1991/1997 to 47 per cent in 1999/2007. A simple T-test
shows that the mean of leverage is significantly different for the period 1999/2007
compared to the period 1991/1997. The result is statistically significant at the 1 per cent
significance level. An increase in leverage shows that a proportion of the cash flow is
used to service debt. The mean (median) Log(TA) is 5.85 (5.75). The mean (median)
firm level risk is 0.68 (0.35) and the inter-quartile range of 0.18-0.79. The mean (median)
business level risk is 0.92 (0.48) and the inter-quartile range of 0.19 to 1.15.
On average, 16 per cent of the companies in the sample belong to primary industry,
8 per cent energy, 21 per cent goods, 13 per cent property, 37 per cent service, 3 per cent
investment and 3 per cent overseas. This provides an opportunity to study the
differences in the corporate governance practices in different industries in New
Zealand.

4.2 Correlation analysis

Table II presents a pairwise correlation matrix for the independent variables.
Governance variables are not highly correlated with each other. There is a positive
correlation between BDS and board sub-committees (ACOM and RCOM). This
indicates that larger boards tend to have sub-committees. Block ownership (BOWN) is
positively correlated with IOWN indicating that firms that have block owners also
tends to have higher insider ownership. Company size is positively correlated with
BOWN, NED, BDS and board sub-committees. The highest correlation of the
independent variables is between IND4 and RCOM at 2 0.62. None of the pairwise
correlations between independent variables are above 0.62, indicating that the
likelihood of multicollinearity issues arising in the OLS regressions is low.

4.3 OLS regression of Tobin’s Q, MB and ROA on ownership, control variables and
compliance variables
Table III presents the OLS regression of equation (2)[4]. Columns 2 and 3, 5 and 6, and 8
and 9 of Table III provide coefficients of independent variables that are used in
equation (2). Table III, columns 2 and 3 provides coefficients of the independent
variables using Tobin’s Q as a dependent variable. The independent variables BOWN
and DIV2TA have positive coefficients, indicating that these variables have a positive
effect on firms’ financial performance measured by Tobin’s Q. Both these variables are
statistically significant at 5 per cent level.
A negative coefficient for Log(TA), which is statistically significant at 1 per cent level,
indicates that size has a negative effect on Tobin’s Q. This raises questions about the
size of large companies in New Zealand as to whether they increase size to derive
 LOWN BOWN NED BDS LEV DIV2TA ACOM RCOM Log (TA) FMRISK BUSRISK

IOWN –
BOWN 0.211** (0.000) –
NED 20.014 (0.793) 20.037 (0.497) –
BDS 0.055 (0.314) 0.319** (0.000) 20.010 (0.858) –
LEV 0.015 (0.787) 20.025 (0.646) 0.144** (0.008) 0.209** (0.000) –
DIV2TA 0.032 (0.558) 20.011 (0.842) 20.069 (0.207) 0.008 (0.876) 20.180** (0.001) –
ACOM 20.164** (0.002) 20.028 (0.609) 0.047 (0.386) 0.134* (0.014) 0.108* (0.046) 20.044 (0.420) –
RCOM 20.016 (0.774) 20.063 (0.250) 0.068 (0.209) 0.411** (0.000) 0.276** (0.000) 0.113* (0.037) 0.264** (0.000) –
Log(TA) 20.294** (0.000) 0.190** (0.000) 0.190** (0.000) 0.361** (0.000) 0.512** (0.000) 20.243** (0.000) (0.144)** (0.000) 0.080 (0.142) –
FMRISK 20.016 (0.774) 0.196** (0.000) 0.172** (0.002) 0.313** (0.000) 0.201** (0.000) 0.075 (0.170) 0.057 (0.298) 0.239** (0.000) 0.359** (0.000) –
BUSRISK 0.118* (0.029) 0.175** (0.001) 0.016 (0.775) 0.201** (0.000) 0.113* (0.037) 0.108* (0.046) 0.084 (0.124) 0.132* (0.000) 0.133* (0.014) 0.369** (0.000) –

Notes: This table reports pairwise correlations between all the independent variables where *indicates significance at the 5 percent level; **indicates significance at 1 percent level
Principle-based

governance
corporate

independent variables
Correlation matrix for
203

Table II.
 6,3

204
IJMF

variables
Table III.

ROA as the dependent

OLS regression estimates
using Tobin’s Q, MB and
Equation 2
Q MB ROA
Standard error Standard error Standard error
Independent after adjusted for after adjusted for after adjusted for
variable clustering clustering clustering

Constant 0.684 * * (3.06) 0.244 0.841 * * * (3.93) 0.213 0.029 (1.23) 0.023
IOWN 0.028 (0.44) 0.063 20.137 * (22.27) 0.060 2 0.007 (21.01) 0.007
BOWN 0.199 * * (2.81) 0.071 0.282 * * * (4.17) 0.068 0.012 * (1.97) 0.007
NED 2 0.001 (20.20) 0.071 0..009 (0.15) 0.068 2 0.005 (20.75) 0.007
BDS 0.186 (1.42) 0.150 20.181 (2 1.45) 0.125 2 0.001 (20.11) 0.013
ACOM 2 0.005 (20.08) 0.063 0.068 (0.13) 0.060 0.002 (0.35) 0.006
RCOM 0.165 * * (3.61) 0.046 0.206 * * (2.45) 0.043 0.023 * * (2.67) 0.005
LEV 0.078 (1.42) 0.055 0.252 * * (4.83) 0.052 20.016 * * (2 3.96) 0.005
DIV2TA 0.291 * (2.01) 0.145 0.351 * (2.54) 0.138 0.087 * * * (5.91) 0.015
Log(TA) 2 0.127 * * * (25.68) 0.023 20.107 * * * (25.04) 0.021 20.009 * * * (2 3.92) 0.002
FMRISK 0.002 (0.12) 0.015 0.023 (1.57) 0.015 0.002 (1.14) 0.002
BUSRISK 0.032 * * (2.85) 0.011 0.020 (1.85) 0.010 2 0.001 (20.71) 0.001
ComAft 0.092 * * * (3.46) 0.006 0.117 * * * (4.88) 0.043 0.009 * * (2.90) 0.005
SURV 0.107 (1.30) 0.050 0.126 (1.60) 0.047 0.002 * * (2.71) 0.005
RGDP 2 0.913 * * (2.56) 1.39 0.003 (0.00) 1.33 0.147 (1.04) 0.141
Adjusted R
squared (R
squared) 0.49 (0.52) 0.40 (0.44) 0.44 (0.47)
F ( p-value) 15.88 (0.000) 11.09 (0.000) 12.90 (0.000)
Industry dummy Yes yes Yes
n 340 340 340
Notes: This table reports the OLS regression results between the dependent variables and the independent variables. Columns 2 and 3, 5 and 6, and 8 and
9 provide coefficients of the independent variables. The columns 4, 7 and 10 reports standard error for each independent variable after it has been adjusted
for clustering. The significance is indicated by *, * *, and * * * for 10 percent, 5 percent and 1 percent level
personal benefits for the managers. The coefficient of all the industry dummy variables Principle-based
(not reported)[5] are positive (accept IND6) and statistically significant at 5 per cent corporate
level. This indicates that governance practices in these industries contribute positively
towards Tobin’s Q. The coefficient of the RGDP (real annual GDP) is negative and governance
statistically significant at 5 per cent level indicating that growth in the New Zealand
economy during the period contributed negatively towards Tobin’s Q. This may be the
case because growth in New Zealand economy was largely attributable to agricultural 205
exports and the same growth was not experienced by the others sectors of the
economy.
Table III, column 4 provides coefficients of independent variables for equation (2)
using MB as a dependent variable. The results are very similar to columns 2 and 3
apart from insider ownership that has a negative coefficient and is statistically
significant at 10 percent level. This shows that insider ownership contributes
negatively towards firm performance measured by MB. The other statistically
significant results are for BOWN, LEV and DIV2TA, each having positive coefficients.
The results indicate that blockholding, leverage and dividend payouts contribute
positively towards firm performance measured by MB. Firm size (log (TA)) also has a
negative coefficient which is significant at 1 per cent level. This confirms earlier
findings that size is optimal for large companies in New Zealand. The coefficient of the
RGDP is negative and is not statistically significant.
Table III, columns 5 and 6 provides coefficients of independent variables for
equation (2) using ROA as the dependent variable. The results are similar to columns 2
and 3, and 4. The coefficients of BOWN and DIV2TA are positive and statistically
significant at 10 per cent and 1 per cent levels, respectively. However, coefficient of
LEV is negative and is statistically significant at 5 per cent level. The coefficient of the
firm size (Log(TA)) is negative and is statistically significant at 1 per cent level. The
coefficient of IND3 (Goods) is positive (not reported) and statistically significant
indicating that governance practices of firms in the Goods industry contribute
positively towards performance measured by ROA.
The effect of the time period after the NZSC corporate governance recommendations
became effective is captured by the dummy variable AFTER2003. Also to capture the
effect of the NZSC recommendation on companies that were always in compliance with
the NZSC recommendations the dummy variable COMPLIED is used. The effect on the
companies that consistently complied with the NZSC recommendations on
performance since 1999 is captured by the variable COMPLIED. The companies that
were continuously present throughout the sampling period are measured by the
dummy variable SURV. The variable ComAft measures the effect of complying with
the NZSC recommendations after 2003 on performance. ComAft is calculated by
multiplying COMPLIED by AFTER2003.
ComAft has a positive coefficient and is statistically significant at the 1 per cent
level providing evidence that performance is positively associated with the NZSC
compliance after 2003. The results for the time period before year 2004 show that
compliance is negatively associated with firm performance and it is statistically
significant at 1 per cent significance level. This suggests that the time period before
2004 had negative effects on performance and the years after 2004 have a positive
effect on performance. This evidence supports the view that the promulgation of the
NZSC recommendations has a positive effect on performance measured by Tobin’s Q,
IJMF MB and ROA. The companies that survived as NZX listings from 1999 did not show
6,3 significant results. The variable SURV is positive and is statistically significant at 5
per cent percent level. The companies that survived the sampling period were more
adaptive to the NZSC recommendations. In summary, the OLS regression supports the
hypothesis that blockholding, leverage, dividend payouts and complying with the
NZSC recommendations after 2003 have a positive effect on company performance.
206 The hypotheses regarding blockholding (H1b), leverage (H3) and dividend payout (H4)
are supported. However, the hypotheses regarding insider ownership (H1a), board
independence (H2a) and board size (H2b) are not supported. The Sheffield survey
shows that managers in New Zealand are often rewarded for reasons other than
meeting performance targets which points to insider ownership not being linked to
firm performance in New Zealand (Hembry, 2008). There is evidence of a positive
relationship between governance practices in different industries, such as, IND3
(Goods) and IND7 (Overseas) on performance. This evidence supports the view that the
principle-based governance approach has allowed different industries to develop
industry specific governance structures which have a positive effect on performance.
There is consistent evidence of company size having a negative effect on performance.
OLS results in Table III show that tolerance (1 2 R 2) ranges from 0.46 to 0.60 and
variance inflation factor (VIF) (1/Tolerance) range from 1.67 to 1.96, are within
acceptable range. According to Menard (1995) tolerance below 0.2 and VIF above 10
are worthy of concern, which needs to be investigated.
The next stage of the analysis looks at whether there is any evidence of piecewise
relationship between insider ownership and firm performance, similar to the studies of
Morck et al. (1988) and McConnell and Servaes (1990).

4.5 Piecewise regressions

A survey by Denis and McConnell (2003) show that there is no consensus about the
linearity of the relationship between ownership structure and performance. Table IV
shows results of equation (3). There is no evidence of piece-wise relationship between
insider ownership in large companies in New Zealand and performance. Consideration
of IOWN2, IOWN3 and BOWN2 finds no significant results[6].

4.6 Linear regression of on difference in Tobin’s Q (between 2003 and 2007) on

ownership and control variables
Tables V show the regression results of equation (4). The dependent variable for 2003
is the average of Tobin’s Q for the years 1999 to 2003 which is regressed on the firm
data for 2003. The dependent variable for 2007 is the average of the Tobin’s Q for the
year 2004 to 2007 which is regressed on the firm data for 2007. The dependent variable
DiffAvQ is the difference between AvQ(2007) and AvQ(2003). DiffAvQ measures
whether the companies that comply with NZSC recommendations in 2007 create
positive value compared to the firms in 2003. The AvQ(2003) is 0.95 and AvQ(2007) is
1.09 and DiffAvQ is 1.53. Since DiffAvQ is positive it indicates that companies in 2007,
on average, created more value than in 2003. The results in columns 4 and 5 of Table VI
suggest that only RCOM has a positive coefficient which is statistically significant at
10 per cent level. The results show that an increase in company value in 2007 is
influenced by the establishment of remuneration committees and a positive constant.
 Equation 3
Q MB ROA
Standard error Standard error Standard error
Independent after adjusted for after adjusted for after adjusted for
variable clustering clustering clustering
Constant 0.653 * * (2.63) 0.249 0.845 * * * (3.50) 0.236 0.068 * * (2.72) 0.025
IOWN 20.085 (2 0.86) 0.090 20.238 * (22.53) 0.094 20.020 (2 1.77) 0.010
LESS1 0.027 (0.29) 0.095 0.121 (1.36) 0.089 20.012 (2 1.36) 0.010
BET15 20.043 (2 0.47) 0.093 0.047 (0.53) 0.088 20.017 (2 1.83) 0.009
BET510 0.059 (0.54) 0.108 0.072 (0.70) 0.103 20.017 (2 1.59) 0.011
BET1020 0.064 (0.65) 0.976 0.069 (0.74) 0.093 20.008 (2 0.82) 0.009
OVER20 0.088 (0.91) 0.097 0.167 (1.81) 0.092 20.005 (2 0.49) 0.009
BOWN 0.191 * * (2.65) 0.072 0.261 * * * (3.81) 0.068 0.009 (1.19) 0.007
NED 0.015 (0.21) 0.070 0..012 (0.18) 0.068 20.003 (2 0.45) 0.007
BDS 20.231 (2 1.74) 0.133 20.214 (2 1.69) 0.126 20.001 (2 0.14) 0.013
ACOM 0.002 (0.03) 0.063 20.017 (2 0.29) 0.060 0.002 (0.40) 0.006
RCOM 0.165 * * (3.57) 0.046 0.166 * (1.96) 0.044 0.022 * (2.45) 0.005
LEV 0.061 (1.11) 0.055 0.234 * * * (4.51) 0.052 20.018 * * * (23.31) 0.006
DIV2TA 0.247 (1.69) 0.146 0.338 * * (2.53) 0.139 0.081 * * * (5.69) 0.015
Log(TA) 20.123 * * * (25.23) 0.024 20.115 * * * (25.17) 0.022 20.009 * * * (23.82) 0.002
FMRISK 0.034 (0.14) 0.015 0.024 (1.64) 0.015 0.002 (1.42) 0.002
BUSRISK 0.024 * * (3.03) 0.011 0.025 * (2.35) 0.011 20.001 (20.41) 0.001
ComAft 0.076 * * * (3.50) 0.045 0.121 * * * (4.73) 0.043 0.010 * * (3.15) 0.005
SURV 0.027 (0.54) 0.051 0.101 (1.22) 0.048 0.025 * * (2.82) 0.005
RGDP 0.821 (0.59) 1.39 20.288 (2 0.22) 1.32 0.142 (1.01) 0.141
F ( p-value) 13.20 (0.000) 9.53 (0.000) 10.96(0.000
Adjusted R
squared (R
squared) 0.49 (0.53) 0.44 (0.55) 0.44 (0.49)
Industry dummy Yes Yes Yes
n 340 340 340
Notes: This table reports the piecewise OLS regression results of the between the dependent variables and the independent variables. Columns 2 and 3, 5
and 6, and 8 and 9 provide coefficients of the independent variables. The columns 4, 7 and 10 reports standard error for each independent variable after it
has been adjusted for clustering. The significance is indicated by *, * *, and * * * for 10 percent, 5 percent and 1 percent level
Principle-based

governance
corporate

using Tobin’s Q, MB and

OLS regression estimates

variables
ROA as the dependent
207

Table IV.
 6,3

208
IJMF

Table V.

using average Tobin’s

the dependent variables

Q(2007) and DiffAvQ as
Q(2003), average Tobin’s
OLS regression estimates
Equation 4
AvQ(2003) AvQ(2007) DiffAvQ
Robust standard Robust standard Robust standard
Independent variable 2003 error 2007 error error

Constant 0.692 (1.42) 0.489 2.67 * * * (4.21) 0.538 1.378 * (2.28) 0.604
IOWN 0.289 (1.23) 0.234 0.256 (0.97) 0.264 20.498 (21.72) 0.289
BOWN 0.346 (1.61) 0.214 0.106 (0.47) 0.355 20.219 (20.53) 0.410
NED 2 0.099 (2 0.43) 0.228 20..011 (20.30) 0.357 20.039 (20.97) 0.039
BDS 0.097 (0.22) 0.449 20.750 (21.14) 0.659 20.130 (20.18) 0.738
ACOM 0.252 (1.41) 0.178
RCOM 0.157 (1.31) 0.120 0.461 * * (2.49) 0.185 0.473 * (2.03) 0.233
LEV 0.158 (0.67) 0.233 0.298 (0.88) 0.337 20.201 (20.53) 0.376
DIV2TA 3.15 * * (3.30) 0.954 20.278 (21.06) 0.261 20.312 (21.09) 0.286
Log(TA) 2 0.177 (2 1.86) 0.095 2 0.209 * * (2 2.58) 0.081 0.092 (0.99) 0.094
FMRISK 0.026 (0.48) 0.055 20.005 (20.05) 0.112 0.001 (0.01) 0.127
BUSRISK 2 0.007 (2 0.20) 0.036 0.105 (1.03) 0.101 20.083 (20.73) 0.113
SURV 0.486 * * (0.44) 0.141 0.032 (0.29) 0.113
CSURV 20.229 (21.78) 0.128
Adjusted R squared (R
squared) 0.64 (0.76) 0.28 (0.45) 0.12 (0.34)
Chi square ( p value) 6.62 (0.000) 2.73 (0.000) 1.55 (0.383)
n 38 45 45
Notes: To investigate if the compliance with NZSC recommendations after 2003 has improved firm performance, the following dependent variables were
computed Average Q for 2003 (AvQ2003), Average Q for 2007 (AvQ2007) and DiffAvQ (AvQ2007 – AvQ2003) This table reports the OLS regression
results between the dependent variables and the independent variables. Columns 2 and 3, 5 and 6, and 8 and 9 provide coefficients of the independent
variables. The columns 4, 7 and 10 reports standard error for each independent variable after it has been adjusted for clustering. The significance is
indicated by *, * *, and * * * for 10 percent, 5 percent and 1 percent level
 IOWN Q IOWN MB IOWN ROA
Robust Robust Robust
Independent standard standard standard
variable (using OLS) (using 2SLS) error (using OLS) (using 2SLS) errors (using OLS) (using 2SLS) error

Constant 0.44*** (3.55) 0.060*** (2.98) 0.202 20.13 (2 1.20) 0.62** (2.98) 0.208 0.51*** (4.14) 0.06** (3.05) 0.021
Q 20.00 (2 0.02)
MB 0.13** (3.24)
ROA 20.61 (2 1.31)
IOWN 0.02 (0.30) 0.062 0.09 (1.58) 0.059 0.01 (0.47) 0.006
BOWN 0.34*** (5.62) 0.26*** (4.08) 0.065 0.25*** (5.25) 0.07 (0.49) 0.071 0.34*** (5.80)
0.01 (1.26) 0.007
NED 0.08 (1.29) 0.01 (0.15) 0.068 20.09 (2 1.69) 0.00 (0.02) 0.069 0.07 (1.11)
20.01 (2 0.82) 0.007
BDS 0.17 (1.59) 20.22 (21.76) 0.125 0.32** (3.42) 20.14(21.11) 0.126 0.18 (1.70)
20.00 (2 0.04) 0.010
ACOM 0.01 (0.16) 0.062 0.01 (0.19) 0.063 20.00 (2 0.29) 0.006
RCOM 0.19*** (3.55) 0.052 0.20*** (3.78) 0.053 0.01 (0.91) 0.005
LEV 0.22*** (4.71) 0.09 (1.81) 0.050 20.22*** (2 5.39) 0.04 (0.70) 0.052 0.21*** (4.60) 2 0.02** (23.46) 0.005
DIV2TA 0.35** (2.50) 0.139 20.16 (2 1.33) 0.34** (2.36) 0.142 0.09*** (6.13) 0.014
Log(TA) 20.14 *** (2 7.54) 20.14*** (26.67) 0.020 0.10*** (5.62) 20.12*** (2 5.22) 0.022 2 0.15*** (28.51) 2 0.01*** (24.20) 0.002
FMRISK 0.01 (0.50) 0.01 (0.42) 0.015 0.01 (0.74) 0.01 (0.55) 0.015 0.01 (0.70) 0.01 (1.12) 0.001
BUSRISK 0.03** 0.011 0.01 (1.05) 0.03** (2.81) 0.142 20.00 (2 0.67) 0.001
RGDP 20.587*** (22.587) 1.11 20.657*** (3.67) 1.675 20.587 (2 2.587) 1.11
COMAFT 0.09*** (4.11) 0.023 0.10*** (4.14) 0.023 0.01** (2.47) 0.002
CSURV 20.03 (20.83) 0.047 20.05 (2 1.46) 0.038 20.01 (2 1.51) 0.004
Mktshare 0.01 (0.11) 0.03* (2.27) 0.012 0.020 (1.71) 0.012 0.01 (1.13) 0.01 (1.69) 0.001
Int2ta 0.01 (1.03) 0.16** (4.23) 0.037 0.144*** (3.70) 0.038 0.00 (0.01) 20.01 (2 1.18) 0.004
F ( p-value) 11.03 (0.000) 17.95 (0.000) 10.76 (0.000) 16.59 (0.000) 11.27 (0.000) 12.51 (0.000)
Adjusted R
squared (R
squared) 0.21 (0.23) 0.53 (0.56) 0.24 (0.27) 0.50 (0.53) 0.21 (0.24) 0.46 (0.43)
Industry
dummy Yes Yes Yes Yes Yes Yes
n 340 340 340 340 340 340

Notes: This table reports the 2SLS regression results of the dependent variables (Q, MB, and ROA) and the independent variables. Columns 2 and 3, 7 and 8, and 12 and 13 provide the results of OLS
regression used to determine insider ownership as dependent variable in the first stage of the regression. The OLS result of the dependent variable is used to determine the coefficients of the independent
variables in the 2SLS regression. Columns 4 and 5, 9 and 10, and 14 and 15 provide the results of 2SLS regression. Columns 6, 11 and 16 report the standard errors for the 2SLS regression. The
significance is indicated by *, **, and *** for 10 percent, 5 percent and 1 percent level
Principle-based

governance
corporate

Estimates of IOWN using

using SSLS
OLS and estimation of Q
209

Table VI.
IJMF The remuneration committee is seen to be an important mechanism for reducing
agency cost related to setting managers’ remuneration.
6,3
5. Robustness
The panel data methodology allows control for heterogeneity through individual effect,
in which the common determinants of ownership and value will be included. However,
210 if an endogeneity problem stems from the lack of consideration of the potential inverse
causality, then ownership variables will be correlated with the random disturbances
(i.e. E(xit. eit) – 0), once the individual effect has been controlled for. To control the
effect of inverse causality, this study uses 2SLS regression technique. In the first stage,
ownership is determined by using OLS regression techniques and in the second stage,
values determined for ownership are used to determine performance. The models
formulated are based on Tobin’s Q, MB and ROA as dependent variables. The
following variables SIZE, LEV, Int2ta and Mktshare are treated as instrumental
variables. Int2ta is determined by dividing the book value of intangible assets by the
total assets. Mktshare is the proportion of the net sales revenue of the firm to the total
sales revenue of the industry. The equations formulated for this study are:
IOWN ¼ a5 þ b50 FP þ b51 BOWN þ b52 NED þ b53 BDS þ b54 LEV

þ b55 logðTAÞ þ b56 FMRISK þ b57 Mktshare þ b58 Int2ta þ e ð5Þ

BOWN ¼ a6 þ b60 FP þ b61 IOWN þ b62 NED þ b63 BDS þ b64 LEV

þ b65 DIV2TA þ b66 logðTAÞ þ b67 FMRISK þ b68 BUSRISK

þ b69 Mktshare þ b70 Int2ta þ e ð6Þ

FP ¼ a7 þ b70 IOWN þ b71 BOWN þ b72 NED þ b73 BDS þ b74 LEV

þ b75 DIV2TA þ b76 ACOM þ b77 RCOM þ b78 LogðTAÞ þ b79 FMRISK

þ b80 BUSRISK þ b81 ComAft þ b82 CSURV þ b83 Mktshare þ b84 Int2ta

þ b85 RGDP þ b86 IND1 þ b87 IND2 þ b88 IND3 þ b89 IND4 þ b90 IND5

þ b91 IND6 þ b92 IND7 þ e ð7Þ

where FP ¼ Tobin’s Q, MB or ROA.
The results of the OLS and 2SLS regression are presented in Tables VI and VII.
Table VI shows OLS and 2SLS regression for IOWN. The OLS regression for IOWN
shows consistent results across all three performance measures (Q, MB, and ROA), that
is, BOWN and LEV have positive coefficient and are statistically significant at 1 per
cent significance level. This supports the view that presence of blockholders and
creditors leads to higher insider ownership. The coefficient of Log(TA) is negative and
is statistically significant at 1 per cent level. This supports the view that the fraction of
the shares owned by insiders in these large companies is only small compared to total
 BOWN Q BOWN MB BOWN ROA
Robust Robust Robust
Independent standard standard standard
variable (using OLS) (using 2SLS) error (using OLS) (using 2SLS) errors (using OLS) (using 2SLS) error

Constant 20.13 (2 1.20) 0.62*** (2.98) 0.208 20.11 (21.08) 0.88** (4.27) 0.206 0.28** (3.08) 0.07*** (3.24) 0.021
Q 0.13** (3.24)
MB2ROA 0.16*** (3.85)
ROA 0.08 (0.19)
IOWN 0.25*** (5.35) 0.09 (1.58) 0.059 0.27*** (5.80)
20.05 (0.86) 0.059 0.17*** (3.78)
20.00 (20.49 0.006
BOWN 0.07 (0.49) 0.071 0.03 (0.41) 0.071 0.01 (1.27) 0.007
NED 20.09 (2 1.69) 0.01 (0.02) 0.069 20.10 (21.88) 0.01 (0.11) 0.069 2 0.06 (21.14) 20.01 (20.89) 0.007
BDS 0.32** (3.42) 20.14 (21.11) 0.126 0.32 ** (3.45) 20.09 (20.73) 0.125 0.49 *** (5.29) 0.01 (0.47) 0.013
ACOM 0.01 (0.19) 0.063 20.02 (20.30) 0.062 20.00 (20.53) 0.006
RCOM 0.20*** (3.78) 0.053 0.11** (2.09) 0.053 0.00 (0.67) 0.005
LEV 20.22*** (25.39) 0.04 (0.70) 0.052 20.25*** (2 5.87) 0.19*** (3.78) 0.051 20.11** (22.70) 20.02** (23.37) 0.005
DIV2TA 20.16 (2 1.33) 0.34** (2.36) 0.142 20.16 (21.39) 0.35** (2.45) 0.141 2 0.21 (21.61) 0.09*** (5.83) 0.015
Log(TA) 0.10*** (5.62) 2 0.12*** (25.52) 0.022 0.09*** (5.71) 20.10*** (2 4.43) 0.022 20.09*** (24.31) 20.01*** (24.12) 0.003
FMRISK 0.01(0.74) 0.01 (0.55) 0.015 0.01 (0.44) 0.03 (1.68) 0.015 0.03* (2.14) 0.00 (1.31) 0.004
BUSRISK 0.01 (1.05) 0.03** (2.81) 0.011 0.011 (1.27) 0.03* (2.26) 0.010 0.02 (21.72) 20.01 (20.48) 0.001
RGDP 21.15 (20.84) 1.37 20.304 (20.22) 1.363 0.14 (0.99) 0.141
COMAFT 0.10*** (4.14) 0.023 0.12*** (5.21) 0.023 0.01** (2.58) 0.002
CSURV 20.05 (21.46) 0.038 20.04 (20.99) 0.037 20.01 (21.21) 0.004
Mktshare 0.03** (22.65) 0.020 (1.71) 0.012 20.02** (2 2.44) 0.010 (0.86) 0.012 2 0.02 (21.49) 0.00 (1.64) 0.102
Int2ta 20.07* (22.17) 0.14** (3.70) 0.038 20.04 (21.29) 20.07 (21.82) 0.037 2 0.06 (21.72) 20.01 (21.31) 0.001
F ( p-value) 10.76 (0.000) 16.59(0.000) 10.27 (0.000) 9.93 (0.000) 7.81 (0.000) 12.49 (0.000)
Adjusted R
squared (R
squared) 0.24 (0.27) 0.50 (0.53) 0.25 (0.27) 0.38 (0.41) 0.17 (0.19) 0.43 (0.46)
Industry
dummy Yes Yes Yes Yes Yes Yes
n 340 340 340 340 340 340

Notes: This table reports the 2SLS regression results of the between the dependent variables (Q, MB, ROA) and the independent variables. Columns 2 and 3, 7 and 8, and 12 and 13 provide the results of
OLS regression used to determine block ownership as dependent variable in the first stage of the regression. The OLS results for the dependent variable are used to determine the coefficients for the
independent variables in the 2SLS regression. Columns 4 and 5, 9 and 10, and 14 and 15 provide the results of 2SLS regression. Columns 6, 11 and 16 report the standard errors for the 2SLS regression.
The significance is indicated by *, **, and *** for 10 percent, 5 percent and 1 percent level
Principle-based

governance
corporate

of Q using SSLS
using OLS and estimation
Estimates of BOWN
Table VII.
211
IJMF shares issued. When insider ownership is considered to be endogenous, variable IOWN
6,3 is no longer statistically significant across all performance measures. The coefficients
of 2SLS regression for the independent variables are listed in columns 4 and 5, 9 and 10
and 14 and 15 of Table VI. Variables BOWN, RCOM, LEV, DIV2TA, and ComAft are
positive and are statistically significant. This confirms the earlier findings of Tables III,
IV and V that the presence of blockholding, remuneration committee and compliance to
212 NZSC recommendations leads to an improvement in the performance of large
companies in New Zealand.
This study does not support the view that insider ownership has had a positive
effect on firm performance measured by Q, MB and ROA. The use of variables, such as,
mktshare and int2ta has improved the predictive power of the model as indicated by
both the adjusted R 2 and R 2. The results in Table VI show that both variables are
positive and statistically significant at 5 percent and 10 percent level, respectively. The
adjusted R2 (R 2) increased from 0.49 (0.52) in Table IV to 0.53 (0.56) in Table VI. This
provides evidence that the effect of the unobservable values in the model have been
captured by these variables, therefore rejecting the hypothesis that E(xit.ut – 0). The
argument by Demsetz and Lehn that insider ownership does not affect performance is
supported. The results for 2SLS regression treating IOWN as endogenous is similar to
the OLS regression results given in Tables III, IV and V. The test for the hypothesis
that E(xit. eit) – 0) is rejected because p-value is high[7] and therefore, supporting the
view that there is no evidence of endogeneity associated with insider ownership.
These findings differ from Hossain et al. (2001) who suggest that there is a link
between insider ownership and performance. Their sample included both small and
large firms. In New Zealand, small companies tend to have a higher proportion of
insider ownership (on average 31.3 per cent) compared to large firms (12 per cent)
(Reddy et al., 2008a).
The coefficients of the independent variables for the OLS regression for BOWN are
given in columns 2 and 3, 7 and 8 and 12 and 13 of Table VII. The results are consistent
across all three performance measures (Q, MB, and ROA), indicating that insider
ownership (IOWN), board size (BDS) and firm size (Log(TA) have positive coefficients
and are statistically significant at 5 per cent level. This shows that the presence of
insider ownership, large board and large companies contribute positively towards
block holding. The variables LEV and Marketshare have negative coefficients and are
statistically significant at 5 per cent level, showing that higher levels of leverage and
market share tends to lower the level of block holding in large companies.
The results of 2SLS regression are given in columns 4 and 5, 9 and 10, 14 and 15 of
Table VII. When block ownership is considered to be endogenous, the 2SLS results are
consistent across all three performance measures, that is, Q, MB and ROA. The
ownership variables BOWN and IOWN are not statistically significant across all
performance measures. The evidence supports the view that the inclusion of the
variables mktshare and int2ta have improved the explanatory power of the model, that
is, adjusted R 2 (R 2) increased from 0.49 (0.52) in Table IV to 0.50 (0.53) in Table VII.
The values of the unobservable characteristics of the model are captured by these
variables and not supporting hypothesis that E(xit.ut – 0). On the other hand results
for the 2SLS regression support the view postulated by Demsetz and Lehn (1985) and
Demsetz and Villalonga (2001) that when reverse causality is considered, the
relationship between ownership and performance disappears. The test finds evidence
of reserve causality between block ownership and performance, supporting the Principle-based
hypothesis E(xit. eit) – 0). corporate
The results in Table VII also show that the coefficients of independent variables
RCOM, DIV2TA, BUSRISK and ComAft are positive and statistically significant governance
across all performance measures, that is, Q, MB and ROA. The firm size and leverage
tend to have negative coefficients and are statistically significant. The results support
the view that variation in firm performance is explained by factors other than 213
ownership.
In summary, the OLS and 2SLS regression of the two ownership variables shows
inconsistent results while insider ownership shows consistent findings. The effect of
insider ownership on performance is insignificant, supporting the findings of the
survey undertaken by Sheffield in 2007, that there is no link between pay and
performance in New Zealand. However, the OLS and 2SLS regressions for
blockholding show inconsistent results. The OLS results show that blockholding
contribute positively towards firm performance measured by Tobin’s Q, MB and ROA
and, therefore, can be regarded as an effective mechanism to mitigate agency problems
in large companies in New Zealand. However, 2SLS regressions results in Table VII
show that when inverse causality is considered, the effect of blockholding on
performance is not significant. This supports the findings of Demsetz (1983), Demsetz
and Lehn (1985), Himmelberg et al. (1999) and Demsetz and Villalonga (2001). There is
evidence that the variation in performance is explained by variables other than
ownership. The results are consistent across different performance measures (Q, MB
and ROA) and also for OLS and 2SLS regressions. The results show that RCOM and
DIV2TA have a positive effect on performance. The positive and statistically
significant coefficient of ComAft supports the view that compliance with NZSC
recommendations has a positive effect of company performance. The results also show
that the companies that comply with NZSC recommendations after 2003 have a
positive effect on performance. There are consistent results suggesting firm size and
LEV are inversely related to firm performance.

6. Conclusion
The aim of this study was to explore the efficacy of the principle-based corporate
governance practices on company financial performance, as measured by Tobin’s Q,
market to book (MB) and return on assets (ROA). In order to achieve the aim two
important questions are addressed:
(1) Does compliance with NZSC recommendations lead to an improvement in
performance?
(2) Do companies that comply with NZSC recommendations after 2003 improve
performance?

The governance factors, namely, non-executive directors and board committees

recommended by the NZSC in 2004 are of particular interest. The findings reveal that
large companies in New Zealand, in general, have complied with the Securities
Commission’s guidelines. The findings indicate that large companies in New Zealand
have good governance practices such as non-executive/independent directors and
board committees dating from 1999. Their results show that board independence and
board size do not have any significant effect on firm performance across all
IJMF performance measures. This finding is consistent with the studies conducted in the
6,3 USA, which follows a rule-based governance system. Further, the findings are
consistent with the analyses of Agrawal and Knoeber (1996); Bhagat and Black (1998);
Yermack (1996); Klein (1998); Baxter (2006) and Reddy et al. (2008a).
The results categorically support the view that compliance with NZSC requirements
has improved firm financial performance. The presence of a remuneration committee
214 has a positive effect of firm performance measured by Q, MB and ROA. The coefficient
of audit committee (ACOM) is mixed and not statistically significant indicating that
audit committees do not enhance performance.
The empirical results do indicate that other governance mechanisms, namely,
dividend payout, can be utilised to minimise agency problems in an efficient manner.
Dividend payouts have also contributed positively towards firm financial performance.
Business risk seems to be positively associated with firm performance.
Block ownership is quite high in New Zealand companies, when compared to other
countries, and the OLS regression shows that blockholding is contributing positively
towards creation of shareholder value. However, when endogeneity is considered, the
effect of blockholding on performance disappears. The size of the company is inversely
related to financial performance indicating managers have increased company size for
personal benefits rather than to increase shareholder value. Also leverage is inversely
related to performance indicating that the cost of servicing debt outweighs any
monitoring benefit that is provided.
The question of whether NZSC guidelines cause firms to be more compliance
focused or more strategically focused is dependent on the effect of the governance
factors on performance. The findings strongly support the view that the company
performance is strongly associated with the time period after 2003, indicating
performance does improve after the new mandatory requirements are introduced. This
supports the view that the NZSC recommendations have a positive influence on
company performance measured by Tobin’s Q, MB and ROA.
The evidence also provides support to the view that principle-based governance
approach has allowed different industries to develop industry specific governance
structures. The empirical results reported in Table III show that IND3 (goods) and
IND7 (Overseas) have a positive effect on performance.
The question left unanswered is why the empirical results for the NZSC
recommendations of having non-executive/independent directors do not appear to be
statistically significantly related to performance. The reason could be that the
companies already have good governance structures in place and having
non-executive independent directors does not result in any significant improvement
in performance. Alternatively, non-executive/independent directors are appointed to
fulfil the NZSC recommendations and they lack knowledge about the firm/industry
and therefore, add no value to the company.
Lastly, jurisdictions around the world are adopting the International Financial
Reporting Standards (IFRS). In New Zealand, the Accounting Standard Review Board
(ASRB) in December 2002 determined that entities required to comply with NZ GAAP
under the Financial Reporting Act 1993 would be required to apply NZ IFRS in the
preparation of their financial statements for periods commencing on or after January
2007, with the option to apply from reporting periods beginning on or after 1 January
2005. NZSC (2008) provides evidence that for companies with balance dates from 31
March 2006 to 30 September 2006 a number have complied with the NZ IFRS. The Principle-based
compliance with NZ IFRS will have an impact on the way financial data are collated corporate
and reported. The effect of the change in reporting requirements from NZ GAAP to NZ
IRFS have had on data collected for companies that has reported under NZ IRFS is governance
difficult to identify. Therefore, the readers should apply discretion when trying to
duplicate or extend this study cognisant of the discontinuity in the data series relating
to IFRS introduction. 215

Notes
1. Is also referred as “Codes of Best Practice” in some countries. These are “soft law” (see
Mörth, 2004) or “soft regulation” (see Sahlin-Andersson, 2004) that are non-binding and are
issued by a collective body relating to the internal governance of corporations (Weil, Gotshal
and Manges, LLP, 2004). The first serious “Code of Best Practice” was the Cadbury Report
1992 that issued by a Committee that was set up by the London Stock Exchange and the
Financial Reporting Council. The precursors of the Cadbury Report were the code issued in
the USA in 1978 and Hong Kong in 1989. However, these codes were relatively general and
did not receive much attention (Seidl, 2006).
2. The New Zealand Securities Commission (NZSC), New Zealand Institute of Directors (IOD)
and the New Zealand Stock Exchange (NZX) in 2002 jointly promulgated the
recommendations for the corporate governance practices in New Zealand. On 29 October
2003, NZX adopted those recommendations for the listed companies and on March 2004,
NZSC released those recommendations as a guideline for all New Zealand entities.
3. A non-executive director is classified independent only when he or she does not represent a
substantial shareholder and where the board is satisfied that he or she has no other direct or
indirect interest or relationship that could reasonably influence their judgement and decision
making as a director.
4. Results for equation (1) can be obtained from the authors if required.
5. Can be obtained from the authors if required.
6. Results can be obtained from the authors if required.
7. Test iown_res ¼ 0, F(1,317) ¼ 0.09, Prob . F ¼ 0.7636.

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Corresponding author
Krishna Reddy can be contacted at: krishna@waikato.ac.nz

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