Corporate takeover, over the years, has been a characteristic feature of the business environment, particularly in the US. Takeover plays an important role in capital reallocation, when the actual value of a firm and its potential value are significantly different; there is incentive for outside parties to be interested in its control (Chi-Keung, 2012). Even firms with cost inefficiency would take a high risk of being taken over when its actual value is significantly lower than its potential value (Frydman, Frydman & Trimbath, 2001). Takeover may not always be negative, takeover usually occurs at a premium and through the takeover, cost efficiency can be improved and overall performance enhanced (Healy, Palepu & Ruback, 1992; Lichtenberg, 1992; Switzer,
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1996). Takeover can pressure firm management to keep firm value high so as not to be taken over and the management laid off. One reason why hostile takeover occurs is to replace under-performing management because of their inability to maximize shareholders‟ wealth (Weisback, 1988). Thus, takeover forces managers to do better for shareholders‟ interest in that the firm value can be reflected in the share price.
Bertrand and Mullainathan (2000) measure takeover force as part of a composite governance variable by classifying the measurement of corporate governance into internal and external governance. The external governance is the level of anti-takeover protection. Firms have higher anti-takeover protection when management implement some defenses including poison polls and staggered board to prevent takeover; it means that corporate governance from the market is lower. If the managers of a firm did not do well, the firm will be inefficient and the shares would have low valuation. This takeover defense may hurt shareholders‟ interests. They use these defenses to entrench themselves or benefit privately. It would attract other firms which have more efficient management to take them over at a low price. When the new managers improve the victim firm, its share prices would increase. Thus, lower anti-takeover protection level would provide more market control for the firm and higher level of external governance. Overall, takeover helps to effectively control management self-interest (Chi-Keung, 2012). Takeover is part of the process that eventually reorganizes inefficient organizations (Shivdasani, 1993).
2.4.6.5 Shareholders’ Activities
Baysinger and Butler (1985) find little evidence that corporate governance resolutions initiated by shareholders lead to better firm performance. Smith and Watts (1992) report a positive performance effects for the Shareholder‟s activities of the California Public Employees Retirement System. Huson, Malatesta and Parrino (2004) show that financial institutions could
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be fairly effective in pushing target companies to take steps to comply with their corporate governance proposals. They also found that any short-term valuation effects resulting from activities are dependent on the specific type of governance issues targeted. Gillan (2006) find that shareholder proposals by individuals have small, positive announcement effects, while proposal by institutional investors have a small but significant negative effect on stock prices.
Overall, the empirical literature on shareholder‟s activities in the United States seems to indicate that it has a negligible impact on corporate performance (Black, Jang & Kim, 2003).
In another study, Frankel, Johnson and Nelson (2002) show a negative relationship between earnings and auditor‟s independence, but Ashbaugh, Lafond and Mayhew (2003) and Lacker and Richardson (2004) provide contrary evidence, arguing that the study dwelt more on intrinsic factors. Agrawal and Chadha (2005) find no relationship between neither audit committee independence and the probability that a firm restates its earnings nor the extent auditors provide non-audit services and the probability that a firm restates its earnings.
Furthermore, several studies have examined the separation of CEO and chairman, positing that agency problems are higher when the same person holds both positions. Using a sample of 452 firms in the annual Forbes magazine rankings of the 500 largest U.S. public firms between 1984 and 1991, Yermiack (1996) shows that firms are more valuable when the CEO and board chair positions are separate. Core, Holthausen and Larcker (1999) also find out that CEO compensation is lower when the CEO and board chair positions are separate.
Gompers, Ishii and Metrick (2003) use Investor Responsibility Research Center data, and conclude that firms with fewer shareholders rights have lower firm valuations and lower stock returns. They classified 24 governance factors into five groups: tactics for delaying hostile takeover, voting rights, director protection, other takeover defenses, and state laws. Most of these
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factors are anti-takeover measures so this index is effectively an index of anti-takeover protection rather than a broad index of governance. Millin (2002), in USA, study the possible link between the corporations‟ financial performance and its commitment to ethics. The emphasis of the paper was on attempting to find a link between overall financial performance and an emphasis on ethics as an aspect of corporate governance. Millin found that 26.8% of the 500 largest US public corporations are committed to ethical behaviour towards stakeholders, or emphasize compliance with codes of conduct. The financial performance of these corporations ranked higher than that of those corporations that did not behave in this way. The statistical significance of the difference was high.
Spong and Sullivan (2007), in their study on corporate governance of banks, outline that the previous studies by Davis and Cobb (2009), Lawal (2012), Vafeas (1999), Daily and Dalton (1992), Mehran (1995), Daily and Ellstrand (1996), Salehi and Baezeger (2011), Klein (1998), Weir and Laing (2001), Bhagat and Bolton (2005), Bhagat and Black (2002) and Sanda, Mikailu and Garba (2005) all on board composition and performance, focused primarily on corporate governance of firms while none looked at effect of board composition on bank‟s value.
Bolton (2006) criticizes these studies on board size and performance because they considered just a single measure of governance. Bolton further observed that these studies are also restricted to the Organization for Economic Cooperation and Development (OECD) framework only.
As further observed, most prior studies on corporate governance and performance make use of the market based performance measures and not accounting performance measures. The foregoing, therefore, indicates that previous studies have yielded inconsistent findings on the relationship between corporate governance and financial performance of firms. Some findings contradicted theoretical expectations. This has to be accepted and indeed expected because
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corporate governance is not a “one-size-fits-all” concept. Even firms within a defined ethnic, geographical locality, capital base, risk profile, corporate history and business activity, the same corporate governance system may not be expected to yield the same results across board. The management and personnel arrangements and requirements of each company will be substantially unique. It would therefore not be practicable or reasonable to place all companies within a single defined set of structures and processes. Corporate governance principles should have some degree of flexibility and be allowed to evolve in the light of changing realities and circumstances of a company (Brown & Gorgens, 2009).
2.4.7 Control Variables - Audit Types, Firm Size and Earnings Management 2.4.7. 1 Firm Size
As firms grow, it may become more difficult to sustain and maintain impressive performance (Banz, 1981). This derives from the fact that smaller firms are expected to be more creative, innovative and easily amenable to changes as situations demand; this enhances their value (Lin
& Chen, 2007).
It may, however, be argued that large firms have direct effect on firm performance (Aljifri &
Moustafa, 2007). This is expected as larger firms have more resources to commit to research, development and innovation which can lead to better adaptability and profit performance they have better economies of scale. This is supported by Kumar (2004), who observed that large firms are more efficient than small firms because of economies of scale, skilled employees and market power. It is also likely that larger firms are better performers because they have the ability to diversify their skills and investments (Ghosh, 1998).
Firm size is usually measured as the Log of the total assets (Log TA) of the firm (Alzharani, Ahmad & Aljaaidi 2011; Choi, Han & Lee, 2011). Using ROA as measure of performance,
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Alzharani, Ahmad & Aljaaidi (2011) conclude from their findings that firm size has significant negative effect on firm performance. This is also supposed by the result of the study by Hudaib and Haniffa (2006). The possible reason advanced for this is that smaller firms in the context are more innovative, creative and change more readily, thus enhancing their values than the larger ones.
The results from the studies by Aljifri & Moustafa (2007) show contrary evidence; the results indicate that there is a positive relationship between firm size and performance. This controversy could be explained by the fact that while there are advantages to be gained from firm size, the firms with larger size must remain innovative, creative and willing to embrace changes so as to stay competitive.