Ownership Types, Corporate Governance and Corporate ... · - 31 - Ownership Types, Corporate Governance and Corporate Performance: The Mediating Effect of Corporate Governance Practices

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Ownership Types, Corporate Governance and Corporate Performance: The Mediating Effect of Corporate Governance Practices

Gayan S. Mapitiya

Abstract

Observing the role of corporate governance practices through the lens of agency theory, this paper contributes to the existing knowledge in �� corporate governance practices in generating corporate performance �� direct relationships between ownership types, corporate governance and corporate performance were assessed, leading to an integrated model focusing on the mediating role of corporate governance. The study was conducted as a quantitative study based on secondary data �� !!"#�!$%�� governance practices mediate the relationship between ownership types and corporate performance. Further, it reveals that ownership �� and corporate governance practices. The study shows that a closely held �� The study further reveals that ownership type is positively associated ��

Keywords: Ownership Types, Corporate Governance, Corporate Performance, Widely Held, Closely Held, Agency Theory, Board of Directors

Mr. Gayan S. Mapitiya is a Lecturer of the Department of Commerce, Faculty of Management Studies and Commerce, University of Sri Jayewardenepura. E-mail: [email protected]

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Introduction

The importance of corporate governance (CG) became very clear as a result of many corporate scandals, failures, frauds and bankruptcies that took place around the world in recent times (Kaur & Gill, 2008). A number of large American, European and Asian corporations including Enron, WorldCom, Xerox, Tyco, Adelphia, Global Crossing, Parmalat, European’s Enron, Hong Guang Co., Lan Tian Co., and Tong '��*�+�� /1��& Geng, 2008). Lack of sound corporate governance practices was considered one of the main reasons for these crises (Haat, Rahman, & Mahenthiran, 2008). Issues related to CG practices received considerable attention from the public, from as well as academics, from policy makers and regulators recently, as it is a key factor that contributes to the success of companies and the economic health of society (Klein, Shapiro, & Young, 2005, Kaur & Gill, 2008, Azim, 2012). Therefore, the need for more effective monitoring mechanisms to improve corporate governance systems became much clearer (Cazurra & Aguilera, 2004). Barton (2004) stated that investors are willing to pay a premium of 25 percent for a well-governed company.

Shareholders are the owners of companies (Monks & Minow, 1995), and these owners are of different types (Connelly, Hoskisson, Tihanyi, & Certo, 2010). For ��+��6��+�7��+�;��/$"""<�� including individual, family, state and widely held. Also, Gollakota & Gupta (2006) �� +� ��+� ��+� �� of ownership. Most of the companies in Anglo-Saxon countries like the U.S.A. and the U.K. are widely held. On the other hand most companies in Asian countries are closely held by individuals and families (Claessens & Fan 2003, Wei & Geng, 2008). In fact, different ownership types result in different CG systems in companies (Mollah, Farooque, & Karim, 2012). Also, ownership is considered an important component of a CG system (Klein, Shapiro, & Young, 2005). Corporate governance issues arise due to the separation of ownership and management (Jensen M. C., $""?<�� N�� +� �� N��+� �� in western countries such as the U.S.A. and the U.K. (La Porta, Shleifer, & Da Silanes, 1999). This view initially derives from Berle and Means (1932), and has been developed by the studies of Jensen and Meckling (1976). Also, the degree of ��N�� the companies. Owners attempt to impose more formal monitoring mechanisms to

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��+��N��(Jensen M. ,1989; Mayer, 1997). Mollah, Farooque and Karim (2012) stated that the corporate governance system varies according to the ownership structure of the corporate sector. Therefore, it is clear that governance practices are driven mainly by the ownership types of companies (Lehmann & Weigand, 2000).

On the other hand, performance is also driven by corporate governance practices (Goh, Rasli, & Khana, 2014), and depends on how effective the mix of monitoring mechanisms is in controlling the agency problem (Agrawal & Knoeber , 1996). Hence, better governance guarantees that owners will get a better return for their investment (Shleifer & Vishny, 1997). That is, the existance of good governance practices would provide better payback to investors (La Porta, Shleifer, & Da Silanes, 1999). It was noted that a lack of proper CG practices in widely held companies motivates managers to misuse company resources at the expense of owners (Jensen ;�[��+�$"\]<+�� +��^�� company resources at the expense of minor shareholders (Shleifer & Vishny, 1997). Therefore, it is obvious that different ownership types lead to different corporate governance practices and, therefore, to different levels of performance. The level of �� than in closely held companies, showing that the level of ownership concentration ��N��

Consequently, it is apparent that both ownership types and corporate governance practices drive performance, and while ownership types drive corporate governance practices. In fact many scholars around the world attempted to identify these three direct relationships (i) ownership types and governance practices (Connelly et al., 2010; Kaur et al., 2008; La Porta et al., 2000; Shleifer,1997; Zheka, 2005) (ii) ownership types and performance (Villalonga et al., 2004; Kaur et al., 2008; Liang, 2011; Pukthuanthong, 2013; Zeitun, 2007) and (iii) governance practices and performance (Klein et al., 2005; Love, 2010; Azim, 2012; Bauwhede, 2009; Black et al., 2006; Shleifer,1997). However, there are hardly any published studies until this particular study which consider all three variables together in one model. It, in fact, results in useful insights for practitioners, policy makers and regulators to �� most appropriate composition of ownership. Further, it is in a manner that generates �� `�� +��and misappropriation of resources, and ensures long term sustainability with

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enhanced risk management strategies of companies. Accordingly, addressing the lacuna in the literature this paper considers corporate governance practices as the mediator between ownership types and corporate performance, since corporate �� N�� N�� j��{��|��/$"?]<+�when three variables have direct relationships with one another as it is in this study, a mediating relationship can be established in a model by considering all three variables together. Hence, this paper raises the question; “Do corporate governance practices mediate the relationship between ownership types and corporate performance”?

In addresing the above research question the researcher intends to achieve the �� ^��~� /�<� �� governance on the relationship between ownership type and corporate performance (ii) to examine the relationship between ownership type and corporate governance (iii) to examine the relationship between corporate governance and corporate performance, and (iv) to examine the relationship between ownership type and corporate performance.

The rest of the paper proceeds as follows: In the next section, the literature related to corporate governance, ownership types, corporate performance and agency theory is discussed. Thereafter, the hypotheses are developed and the theoretical framework �� statistical analysis are presented and discussed. This is followed by a brief discussion of the theoretical, practical and societal implications along with the limitations and suggestions for future research. The last section presents the concluding remarks.

Literature Review

Corporate Governance

Good corporate governance is accepted as vital to achieving the millennium development goals and sustainable economic growth (Mwanja, Marangu, Wanjere, ;��+��!$�<��*� �� /��`��+� �!!"<+� �� implications for the economic development and social well-being of a country (Clarke, 2004). More importantly, corporate governance becomes a multifaceted subject due to the complexity in globalization of business operations (Monks & Minow, 1995).

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According to Clarke (2004), corporate governance involves the exercise of power to direct and control companies. Many studies have cited the failure of corporate ��/{� ��G. A., 2013). Moreover, corporate governance is of critical importance to investors, insurers, regulators, creditors, customers, employees and other stakeholders of companies (Haat, Rahman, & Mahenthiran, 2008). Also, Mollah, Farooque, & Karim (2012) reported that corporate governance mechanisms are market, institutional and legal settings that protect outside investors from the opportunistic behaviour of managers or controlling shareholders.

Corporate governance is an essential part of risk management for shareholders ( Charkham & Simpson , 1999). Cazurra & Aguilera (2004) state that good governance practices consider the issues related to role, composition, remuneration, selection and dismissal of the board of directors, relationships with shareholders and top management, auditing and information disclosure. Clarke (2014) states that boards of directors are an essential part of the DNA of corporations, and corporate �� addition, he states that in the absence of such protection, asymmetries of information �� misallocate and expropriate corporate resources, often at the expense of minority ��#�� [�� governance explain corporate governance as a system utilized to shield investors’ �� /��+� �!$�<�� ;� �� /$""\<� �� a return on their investment. Also, Bokpin, Isshaq, & Otchere (2011) reported that corporate governance is a system of mechanisms that serve to ensure that shareholder wealth is maximized and it does so via several methods geared toward enforcing the stewardship responsibilities of managers. Thus, the researcher argues that corporate governance is a vital mechanism for an organization to survive in a competitive and turbulent business environment and also to achieve its long-term goals.

[��*��of corporate governance was introduced in the late 1970s in the USA emphasizing the role of the board of directors (Cazurra & Aguilera, 2004). However, the Cadbury �� |�� $""�� N�� *�� /��;��+� $""%<+�� /*�`��;�j��+��!!�<��*��*��

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governance as the system by which companies are directed and controlled (Cadbury, 1992). In Sri Lanka a code of best practices on governance was jointly issued by the Institute of Chartered Accountants and the Securities and Exchange Commission. The most recent code issued in Sri Lanka was in 2013 with several amendments to the previous governance requirements. This paper is based on a comprehensive �� institutional differences between Sri Lanka and developed countries like the USA, UK and Australia with regard to capital market development (Thilakasiri, 2012). Sri Lanka is a relatively much smaller economy where capital markets are not nearly as well-developed (Heenetigala, 2011). Another factor that distinguishes Sri Lanka from Anglo-Saxon countries such as the UK, USA and Australia, is that the trend of takeovers is virtually non-existent in Sri Lanka (Heenetigala, 2011). Sri Lanka experienced some corporate failures in the late 1980s and in the early 1990s through to 2008, especially in the Banking and Finance industry (Heenetigala, 2011).

Ownership types

Firms may be owned by a diverse mix of different types of investors (Connelly, Hoskisson, Tihanyi, & Certo, 2010). Agency theory suggests that the presence of a large shareholder can lead to better performance because it reduces agency problems between owners and managers (Jensen & Meckling, 1976). La Porta et al., (1999) ��+�|��+�/�!!�<��companies as widely held or not based on the voting rights. La Porta et al., (1999) also stated that several studies (Eisenberg, 1976; Demsetz, 1983; Demsetz and Lehn, 1985; Shleifer and Vishny, 1986; Morck, Shleifer and Vishny, 1988;) show that even ��j��+��

Recent research has documented large differences among countries regarding �� /��6��+��#��+��+�;�Vishny, 2000). Large shareholdings or majority ownership is relatively uncommon in the USA and the UK, but in most European countries as well as in Latin America, ��j��j��+�� /1��;��+�2008). Furthermore, La Porta et al., (2000) cited that studies of other rich nations �� +� �� (Edwards and Fischer, 1994; Franks and Mayer, 1994, and Gorton and Schmid,1996) Japan (Prowse,1992; Berglof and Perotti, 1994) Italy (Barca ,1995) and seven

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OECD countries (European Corporate Governance Network,1997). In developing economies, ownership is also heavily concentrated (La Porta et al.,1998;). For instance, in most Sri Lankan listed companies the ownership is concentrated in the hands of a controlling shareholder and widely held entities are rare as in most other Asian countries (Senaratne, 2012). The widely held ownership structure of large ��j��#��N��/��6��+��+�;�7��+�$"""<��

Performance

Performance is mainly driven by corporate governance (Goh, Rasli, & Khana, 2014) and the type of ownership of the companies (Shleifer & Vishny, 1997). Of course, the *�� +��N�� $""�� |+� �� (Stiles & Taylor, 1993). Corporate governance and ownership types may have an �� +� � �� +� �� +� �� /��+�2010; Klein, Shapiro, & Young, 2005)

Agency Theory

The principal-agent governance model presented by Jensen and Meckling (1976) is the foundation of corporate governance studies (Jensen M., 1989). Indeed, the crux of the principal- agent model is the separation of ownership and control, and of course, it is the starting point of most discussions related to corporate governance (Shleifer & Vishny, 1997). Fama and Jensen (1983) stated that the separation of decision-making and risk-bearing is more common in large companies compared to other closely held companies. Furthermore, Lubatkin, Lane, Collin, and Very (2005) documented the fact that agency theory discusses the issues that arise when principals assign decision making powers to agents in any organization. Further, they reported that managers-agents who are involved in day-to-day operations can hide information from widely spread principals-owners who do not have access to this information. Therefore, owners are compelled to invest in monitoring mechanisms to avoid the opportunistic behaviour of managers (Hart, 1995). Hence, it is obvious that unmonitored agents-managers will attempt to achieve their own goals rather than that of owners (Greenwood, Deephouse, & Li, 2007). Therefore, effective corporate �� N�� #��

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principals-owners by improving the use of corporate resources for the maximization of owners’ returns (Love, 2010). This paper depends on the literature on corporate governance, ownership types, performance and agency theory, and proposes that corporate governance mechanisms are vital for an organization to align the interests of owners, who are the risk bearers, having less information and managers, who are the decision makers, having more information in a company.

Propositions and Conceptual Framework

As reported by Shleifer and Vishny (1997) most past studies on ownership types have worked with an agency theory framework which is also used for the present study. Obviously, different ownership types will affect corporate governance practices and corporate performance differently (Lappalainen & Niskanen, 2012). �� +� ��+� ��#�� #��+� �� for the purpose of this paper, as it has been widely used to identify the degree of ownership concentration in corporate governance studies (La Porta et al., 1999; Klein et al., 2005); also it is more convenient to classify companies into these broad ��cut off value of 20 per cent (La Porta et al., 1999; Klein et al., 2005). In addition, this paper focuses principally on board structure and functions in order to understand corporate governance practices, since the board of directors plays a pivotal role in corporate governance, (Mayer, 1997; Krafft, Qu, Quatraro, & Ravix, 2013). Similarly, �� return on assets (ROA) and return on equity (ROE) (Azim, 2012;Bauwhede, 2009).

Relationships between ownership types and corporate performance

j��6��+�/$"""<�� /�� ;� ��+� �!$�<�� j�� |�� /$""]<� �� {�� *� �� /�!!]<� �� +� �� +� ��#��+�|��and Sorensen (1999) suggest that concentrated holdings may lead to increased �� [��+� [�� /�!!�<� ��

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measured by the return on equity and asset utilization. Many studies conducted in the USA have found that corporate performance rises initially with low levels of ownership concentration and then declines. (Morck, Shleifer and Vishny (1988), McConnell and Servaes (1990), and Wruck (1989) as cited by Mayer, (1997)). Also, ��+�� +� ��+��j��#��/*��^��+�6��+�;�'��+��!!�<��+� �� /�!!]<� �� !!� �� +�j��/�!!%<�� #�� the relationship between ownership types and performance into consideration, the following proposition is suggested by the researcher.

��

Relationships between ownership types and corporate governance practices

Agency theory suggests that closely held ownership will result in more effective monitoring (Klein et al., 2005). It further states that ownership should be an important component of a corporate governance system. Research suggests that �� N�� of a variety of governance policies (Bushee et al., 2004 cited by Connelly et al., 2010). Klein et al., (2005) also documented the fact that there is a variation in governance �� *��+�/�!$!<�� N�� N��mechanism. As Connelly et al., (2010) report, managers and executives today are in ��N��+��^��*��N��on corporate governance structure and practices of companies and also owners can �� N�� board activities and in management (Senaratne, 2012). Thus, governance in closely held companies often serves to enable transparency and partnership across the system (Senaratne, 2012). Therefore, it is clear that the extent to which companies comply with governance practices would depend very much on its ownership pattern. Thus, the following proposition is advanced.

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��

Relationships between corporate governance practices and corporate performance

The various corporate governance codes that have been issued since the late $""!�� their corporate governance recommendations (Bauwhede, 2009). Also, Jensen (1993) reported that the expected relationship between compliance with corporate governance recommendations and operating performance is based on the argument �� +��increases their operating performance. One of the earliest studies of the relationship between governance and performance is that of Black et al., (2006) who found a �� j��+�|��+�/�!$%<��#�� [��studies ((Bai et al., 2002; Campbell II and Keys, 2002; Klapper and Love, 2004; Black et al., 2003; Durnev and Kim, 2005 as cited by Klein et al., (2005)) report a �� +� �� in corporate governance practices is associated with better corporate performance. ��+��/�!$%<�� `�� statements will consequently improve corporate performance. Thus, according to the evidence available it is expected that higher compliance with international best practices of corporate governance is related to better operating performance (Bauwhede, 2009). Despite the differences among countries and methodologies, �� ^�� governance and performance (Love, 2010). Hence, the researcher suggested the third propostion as;

��

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Corporate governance practices as a mediator between ownership types and corporate performance

[�� N�� dependent variable (Baron & Kenny, 1986). The following conditions must hold to establish a mediating relationship. First, the independent variable must affect the mediator. Second, the independent variable must be shown to affect the dependent variable and third, the mediator must affect the dependent variable (Baron & Kenny, 1986). In fact, a mediator relationship describes a three-variable system where two causal paths feed into the dependent variable: the direct impact of the independent variable and the impact of the mediator. There is also a path from the independent variable to the mediator. Accordingly, the three hypotheses suggested above show direct relationships between (i) ownership types and corporate governance practices (ii) ownership types and corporate performance and (iii) corporate governance practices and corporate performance. According to Baron and Kenny (1986) when three variables have direct relationships with each other a mediating relationship can be established in a model by considering all three variables together.

Accordingly, this paper considers corporate governance practices as the mediator between ownership types and corporate performance, as corporate governance �� N�� +� �� N�� +� �� principal-agent provides incentives for managers (agents) to act in a self-interested and opportunistic manner, owners (principals) have incentives to invest in formal governance mechanisms (Lubatkin et al., 2005). Hence, the agency theory is applied to explain the mediating role of corporate governance on ownership type and corporate performance. Hsu, Wang et al., (2008) pointed out that by introducing independent directors to the board, the board will undergo tighter monitoring which will alleviate the agency problem. Thus, the mediating role of governance is clearer. Therefore, the following proposition is advanced.

��!��"��

The hypotheses are outlined in Figure 1. The model highlights the fact that ownership types directly relate to corporate performance and corporate governance. In addition it is suggested that while corporate governance practices have a direct relationship

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to corporate performance, it mediates the relationship between ownership types and corporate performance.

The relationships proposed in the above four hypotheses are graphically shown in Figure 1. As shown in the model (i) ownership types directly relate to corporate governance practices, (ii) ownership types directly relate to corporate performance and (iii) corporate governance practices directly relate to corporate performance and most importantly, corporate governance practices mediate the relationship between ownership types and corporate performance.

Figure 1: Conceptual Model

Methodology

Samples and Data

The population of the study consists of companies which are listed on the CSE at the end of November 2014, and accordingly the number of the population is 293 representing twenty sectors. A sample was drawn from the best representation � �� `�� #year. The present study was based on secondary data for which annual reports were downloaded from the CSE web site www.cse.lk. Companies that were listed �� j��+��them often subject to special rules and regulatory requirements, which are different from those of other sectors (Liang, Huang, & L in, 2011; Bauwhede, 2009). Hence, �� !?��A sample of 52 companies was selected as the sample. Firstly, the companies that

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��+��+��+��+��on their market capitalization. Then, seventeen (17) companies were selected from ��+�� /��<�� +��!!"#�!$%��j��+��/�]!<��#��selected sample companies represented fourteen sectors, namely, Chemicals and 6��+�7��+��+�{��+��+�Hotels and Tourism, Health, Land and property, Manufacturing, Oil palms, Power and Energy, Plantation, Stores and Supplies, Telecommunication and Trading, out of the twenty sectors in the CSE.

Measures

Ownership analysis

�� +��and indirect voting rights with a cut off value of 20 per cent (La Porta, Shleifer, & Da ��+�$"""~�|��+�� +�;��+��!!�<��*��+��two ownership types - widely held and closely held. (La Porta et al., 1999; Klein et al., 2005; Senaratne 2012). That is, if any company has a shareholder with voting rights of �!� ��+�� #�� company; otherwise �� #�� for the purposes of this paper. The ownership data was obtained from annual reports of sample companies and their parent companies during the period 2009-2013. When the controlling shareholder of a company is another company, the shareholding of the latter was analyzed, that is the chain of control was analyzed, to identify whether the former company is widely held or not (La Porta, Shleifer, & Da Silanes, 1999). For statistical analysis, ownership dummy ��$��#�� !��#��

Corporate governance Analysis

Corporate governance variables are obtained from the annual reports of sample companies for the period 2009 to 2013. Since the board of directors plays a pivotal role in corporate governance, the paper used an index to measure corporate governance constructed using the following corporate governance variables; Board size, Number of independent directors, Number of board meetings, Percentage of board attendance, CEO duality, Audit committee independence and Remuneration

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committee independence. (Azim, 2012 : Black, Jang, & Kim, 2006: Love, 2010: Krafft, Qu, Quatraro, & Ravix, 2013: Villalongaa & Amitb, 2004: Mishra & Mohanty, 2014). In this study, the approach to scoring items is essentially dichotomous, with ��/$<��+��`��(0) if it does not. The total score T for a company is:

��

Where � is 1 if the item i is disclosed and 0 otherwise; n is the maximum number of items. The main purpose for developing a CG index was to measure the data using a quantitative method in order permit more analyses such as examining the relationships between CG practices and CP.

Performance Analysis

*� �� using two of the accounting based performance measures, return on assets (ROA) and return on equity (ROE) (Wiwattanakantang, (2001); Azim, (2012); Bauwhede, /�!!"<<��j�� +�� period 2009 to 2013. Indeed, ROA gives investors an idea of how effectively company management is using its assets to generate earnings ROE measures how operating ��

Control variables

7��+�� +��+��sector and total assets as control variables of the analysis. Financial leverage was measured as the proportion of total debt to the equity of the company (Klein, �� +�;��+��!!�<��j��+��/��;�j��+��!!�<��+��sector dummies were added to each sector (Lappalainen & Niskanen, 2012), and the natural logarithm of total assets was used to measure the total assets of each company (Bauwhede, 2009; Klein, Shapiro, & Young, 2005; Azim, 2012).

T dit

n

==∑1

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Panel data analysis

Panel data analysis is the most appropriate methodology for the present study ��#��#�� !!"��!$%�/��+��!!?<��+� ��data is described as data collected for individual units observed over a considerable ��/��^��+��!!%~�'��+��!!%<��6��statistical methods available, widely used in econometrics, social science and epidemiology (Maddala, 1986 ). Moreover, several terms have been used to describe panel data, including pooled and longitudinal data, event study and cohort analysis (Gujarati, 2003). STATA is widely used among the statistical packages that excel in programs for panel data analysis (Gujarati, 2003), and STATA appears to have a particularly rich variety of panel analytic procedures (Gujarati, 2003).

Model

To test the relationship between ownership type and corporate performance, ROA and ROE, including the control variables discussed above, the following models are � ��

$�%�&'()1�*()2+�()3%�()4,�()5+�*%(-

$�.&'()1�*()2+�()3%�()4,�()5+�*%(-

Where: ROA = return on assets; ROE = return on equity; OT = Ownership Types; +� = Financial Leverage; %��~�,� = Sector; +�*% = natural log of total assets.

To test the relationship between ownership type and corporate governance practices ��+��

CG067.8�&�'()1�*()2+�()3%�()4,�()5+�*%(-

Where: CGI67.8 = Corporate Governance Index; OT = Ownership Types; +� = Financial Leverage; %��~�,� = Sector; +�*%�= natural log of total assets.

To test the relationship between corporate governance practices and corporate performance, ROA and ROE, including the control variables discussed above the ��

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$�%�&�'()1CG067.8()2+�()3%�()4,�()5+�*%(-

$�.�&�'()1CG067.8()2+�()3%�()4,�()5+�*%(-

Where: ROA = return on assets; ROE = return on equity; CG067.8 = Corporate Governance Index; +� = Financial Leverage; %��~�,� = Sector; +�*% = natural log of total assets.

Analysis and Results

According to the methodology discussed in the previous section, panel data regression analysis was used to identify the relationships between those variables, and the '�� random effects models. The Sobel-Goodman test was used to analyze the mediating role of corporate governance practices. Firstly, the data has been winsorised at the 0.05 level to make sure that outliers do not affect the data analysis.

Table 1 provides descriptive statistics of the dependent and independent variables used in this study.

Table 1: Descriptive Statistics

Variable N mean max min sd p25 p50 p75

Ownership 260 0.79 1.00 - 0.41 1.00 1.00 1.00

CGINDEX 260 4.11 6.00 1.00 1.16 3.0 0 4.00 5.00

ROA 260 11.58 17.79 (4.00) 5.92 10.44 12.74 15.42

ROE 260 13.07 20.67 (8.40) 7.39 12.27 15.01 17.57

LEVERAGE 260 0.55 1.32 0.02 0.42 0.16 0.50 0.90

AGE 260 38.68 99.00 9.00 26.19 19.00 30.00 59.00

The mean value of ownership is 0.79 which shows that a great majority of the sample companies are closely-held. Also, the mean value of CGINDEX, ROA and ROE are 4.11, 11.58% and 13.07% respectively.

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Spearman’s Correlation

Table 2 presents Spearman’s correlation for all the variables in the study.

Table 2: Summary of correlations

Ownership CGINDEX Sector ROA ROE LEVERAGE AGE

Ownership 1.000

CGINDEX -0.421*** 1.000

ROA -0.324*** 0.653*** -0.238*** 1.000

ROE -0.324*** 0.592*** -0.227*** 0.987*** 1.000

LEVERAGE 0.038 -0.032 0.016 -0.158** -0.171*** 1.000

AGE -0.041 0.055 -0.036 0.106* 0.114* 0.012 1.000

* P < 0.10, ** P < 0.05, *** P < 0.01

�� +� �� j� �� !�!$+��#!�%��j��+��2 values for ROA and ROE are 29.9% and 29% respectively. At the same time, ownership types show a �� +�*�INDEX, at the �� !�!$� �� #!��$� �� 2 value of 38.43%. Likewise, the results suggest that corporate governance practices, CGINDEX, �� j��!�!$��*��j��with CGINDEX are 0.653 and 0.592 respectively. Also, R2 values for ROA and ROE are 52.85% and 47.6% respectively.

Corporate governance practices as the mediator of the relationship between ownership types and corporate performance

The purpose of the Sobel-Goodman tests is to see whether a mediator carries the ��N�� +� �� the mediating role of corporate governance practices on the relationship between ownership types and corporate performance in the present study, the researcher has employed the Sobel-Goodman test (Baron & Kenny, 1986; www.ats.ucla.edu, 2015). Table 3 shows the results of the Sobel-Goodman test for the CGINDEX and the ROA. According to the statistical results of the Sobel-Goodman test, the mediating effect �� ?��the total effect of ownership types on ROA being mediated.

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Table 3: The Sobel-Goodman Mediation test: CG practices as the mediator between Ownership types and Corporate performance (ROA)

Proportion/Ratio

Proportion of total effect that is mediated 0.85387536

Ratio of indirect to direct effect 5.8434728

Ratio of total to direct effect 5.8434728

Moreover, Table 4 shows the results of the Sobel-Goodman test for the CGINDEX and the ROE. According to the statistical results of the Sobel-Goodman test, the mediating effect of corporate governance in terms of the CGINDEX was statistically ��\�� performance in terms of ROE being mediated.

Table 4: The Sobel-Goodman Mediation test: CG practices as the mediator between Ownership types and Corporate performance (ROE)

Proportion/Ratio

Proportion of total effect that is mediated 0.75277527

Ratio of indirect to direct effect 3.0449028

Ratio of total to direct effect 4.0449028

��

Having noted the lacuna in empirical studies that examine all three variables, ownership types, corporate governance practices and corporate performance, in one model, this study reports a mediating effect of corporate governance practices in the relationship between ownership types and corporate performance. Unlike previous �� +� �� #�� [�� ]!� ��#�� listed companies in Sri Lanka representing fourteen industrial sectors. The analysis showed that the direct relationships of the above three variables with each other ��

�� and corporate performance is consistent with the results of Shyu (2011); Tian, (2007); Grant and Kirchmaier, (2004) and Shleifer and Vishny, (1997). Furthermore, many studies conducted in the USA have found that corporate performance was found to

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rise initially with low levels of ownership concentration and then decline (Morck, Shleifer and Vishny (1988), McConnell and Servaes (1990), and Wruck (1989) as cited by Mayer, (1997).

��+�� |��+�� +�� /�!!�<� �� +� �� #��+�� j��+� ��*��+� ��concentrated equity ownership in the hands of large state-owned shareholders causes a less effective corporate governance mechanism in Chinese companies (Wei & Geng, 2008). Further, Hermalin (2005) found a negative relationship between �� +� �� #��

�� governance practices and corporate performance. Krafft, Qu, Quatraro, and Ravix /�!$%<�� and ROA. Moreover, studies such as those by Gompers, Joy , and Metrick, (2003), Brown and Marcus (2009) ,Rickson, Park, Reising, and Shin, (2005), Bebchuk, Cohen , and Ferrel, (2006) and Zheka, (2005) found a positive relationship between corporate governance practices and performance. Also, similar results were observed by emerging markets studies like Bai et al., 2002; Campbell II and Keys, 2002; Klapper and Love, 2004; Black et al., 2003; Durnev and Kim, 2005 as cited by Klein et al., (2005).

This paper establishes a mediating effect of corporate governance practices on the relationship between ownership types and corporate performance. In fact, as observed by the reseacher in the current study, there are hardly any published studies on the mediating effect of corporate governance practices until now. The Sobel-Goodman Mediation test showed a mediating effect of corporate governance practices of more than 85% between ownership types and ROA and also more than 75% between ownership types and ROE. Consequently, the paper adds a new facet of corporate governance practices to the existing body of knowledge

According to the analysis presented in the paper, a majority of the sample companies �� +� �� +� �� companies are closely-held. As a percentage it is 77% of the sample. On the other

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hand, only 23% of the sample companies are widely-held. La Porta et al., (1998) found that in developing economies, ownership is heavily concentrated and only 36% of the companies in the world are widely-held. Also, in New Zealand which is ��+��%!�� held. Furthermore, Claessens and Fan (2003) state that one or several members of a family hold tightly onto the shares of a typical Asian corporation.

Theoretical Implications

The paper establishes a mediating effect of corporate governance practices on the relationship between ownership types and corporate performance viewed through the lense of agency theory. In fact, as observed by the reseacher in the current study, there are hardly any published studies on the mediating effect of corporate governance practices until now. Consequently, this lacuna in the existing body of knowledge is bridged by this study adding a new facet of corporate governance practices to the existing knowledge. The understanding in agency theory is that separation of corporate ownership from corporate management leads to poor corporate performance due to misappropriation of corporate resources by the management (Fama & Jensen, 1983). Hence, in widely-held companies management is motivated to deviate from the interests of owners causing low returns to the owners. Further, in closely-held companies major shareholders who also possess management powers are motivated to misappropriate the corporate resources at the expense of the minority shareholders leading to overall poor corporate performance (La Porta, Shleifer, & Da Silanes, 1999). Therefore, the mediating role of corporate governance practices established in this study guides the companies to design and develop an optimal corporate governance structure where corporate performance would be improved regardless of the type of ownership. Hence, the existing theory, �� N��and then to poor performance (Jensen & Meckling, 1976) is imbued with a new facet, that strength of corporate governance practices affects corporate performance under both widely-held and closely-held ownerships. Accordingly, it is advisable to follow strong corpoate governance practices to achieve higher corporate performance. On the other hand, another theoretical value addition of this study is that it brings new ��+��+��`�+��the control variables. This suggests that to achieve higher performance corporate governance practices should be designed and developed by addressing the differences in leverage, age, size and sector.

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Practical Implications

This study provides many useful insights for corporate governance policy makers and regulators in Sri Lanka such as the Securities and Exchange Commission and �� *�� j�� a governance framework which will safeguard corporate resources and improve performance. Further, this study motivates shareholders and directors to formulate an optimal governance structure at the company level leading to better performance by the eradication of malpractices such as corruption, fraud and misappropriation of resources, ensuring long term sustainability with enhanced risk management ��j�� the corporate DNAs of the corporate governance structure, aiming at building �� important to note that investors from western countries are attracted when proper shareholder protection is available in local companies. Since this study shows that better governance leads to better performance, this will lead to reforms in corporate governance practices in Sri Lankan companies in a way that will maximize the company performance, in turn attracting more foreign investors.

Limitations and directions for further research

The study has several limitations which, therefore, need to be addressed in the future. Firstly, the scope of the study was limited to the 52 listed companies in Sri �� listed companies had been included. Therefore, future researchers can expand the �� j��+��year time span from 2009 to 2013. Thus, it is proposed that the time period covered by the study be expanded to have more useful insights. Secondly, from a corporate governance point of view, the study considers only board characteristics, audit committee independence and remuneration committee independence. Therefore, other aspects of corporate governance could be incorporated in future research. Thirdly, as far as corporate performance is concerned this study focused only on accounting based performance measures which were return on assets (ROA) and return on equity (ROE). However, to measure corporate performance in a broader sense, market based measures can be proposed for future researchers. Finally, this �� +�� +�� +�� +��

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and fund management companies due to the unique corporate governance regulations those companies are required to follow. Therefore, it would be very useful if future researchers could undertake studies on those companies and focus on sector-wise studies separately to explore further the relationships studied in this paper.

Conclusion

The present study examined the mediating effect of corporate governance practices on the relationship between ownership types and corporate performance in public listed companies in Sri Lanka. In addition, the direct relationships between (i) ownership types and corporate performance (ii) ownership types and corporate governance practices and (iii) corporate governance practices and corporate performance were also examined. Accordingly, the mediating test shows that corporate governance practices mediate the relationship between ownership types and corporate performance providing new insights on corporate governance for ��#��+��+��+��and redesign the corporate governance structure at company and national level. The �� and corporate performance, indicating that more ownership concentration leads to ��j��+�� types and corporate governance practices implying that corporate governance practices are not complied with when ownership is concentrated. Nevertheless, a �� and corporate performance revealing that strong corporate governance practices lead to higher corporate performance, which in turn motivates companies to build and maintain a sound system of corporate governance.

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