Is Board Independence a Panacea for Improved Corporate Performance? Evidence in a Developing Country Setting

Abstract

Corporate governance was brought back into the limelight over the last decade, with the large number of dramatic corporate collapses around the world which drove some of the financial giants in the finance industry to bankruptcy. The need to revisit the mechanism for monitoring governance, especially since many of the big scandals emanated from the West, where a culture of good corporate governance was seemingly embedded in the corporates. The board of directors has long been recognized as the primary and dominant internal corporate governance mechanism for aligning the interests of managers and all stakeholders to a firm. Separation of ownership from management raises a key issue of how to effectively monitor managers to ensure that they act in the best interest of the shareholders and other stakeholders as well. The role of independent directors in improving the effectiveness of control has been the subject of debate in academic literature, especially in the context of a developing country where unlike in the developed economies, a culture of poor corporate governance is the norm rather than the exception. The paper explores this issue, paying particular attention on the relationship between corporate board independence and firms’ financial performance in a development country setting. Using data obtained from Colombo Stock Exchange, Sri Lanka for the period 2004 through 2009, a sample consisting of fifty firms were used to assess board independence and their impact on performance. Data was gathered through published reports and a primary survey. Independence of the board was deconstructed to board composition as measured by proportion of independent directors and proportion of non-executive directors. The firm performance was measured using both financial and market performance indicators. After controlling for industry, firm size and CEO duality, the results indicate support for stewardship perspective, with no convincing evidence to indicate that inclusion of independent directors is associated with improved financial performance. The weak governance structure which could be exemplified by ownership entrenchment, cross sitting of board members and lack of cumulative voting may explain the lack of evidence found. However, the results indicate that inclusion of independent directors is valued by investors and reflected in enhanced firm value.

Keywords: Board independence, corporate governance, performance

DOI: 10.7176/EJBM/12-33-06

Publication date: November 30^th 2020