Thesis Rizki Putri_926723

Interaction Effect of Corporate Governance Mechanisms

In Multinational State-Owned Enterprises

Master thesis

Name : Rizki Malinda Isvaniari Putri

ANR : 926723

Studies : MSc. International Management

Supervisor : Dr. Gerwin van der Laan

Second Reader : Dr. Shivaram Devarakonda

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Abstract

This study begins with “one size does not fit all” concept which have analyze the corporate

governance mechanism on Multinational State Owned Enterprises (SOEs). In the sample of 49

Multinational SOEs in all over the world, this study contributes to the understanding of the

interaction of corporate governance mechanisms, especially in Multinational SOEs. The analysis of

internal and external corporate governance mechanism reveals that there are the significant

relationships between those mechanisms and firm financial performance in Multinational SOEs.

The study also found if there is an interaction effect between internal and external mechanism of

corporate governance that has a positive effect on the financial firm performance. Those findings

affirm if the internal and external of corporate governance mechanism appear to complete each

other instead of substitute each other. The result of this study also offered the optimal corporate

governance mechanism to Multinational SOEs and the reference for government to establish

corporate governance policy for SOEs, it must be considered that SOEs which will be or already

had internationally system have different corporate governance atmosphere compare to other state

owned enterprises and other multinational private firm.

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Table of Contents

Abstract ........................................................................................................................................................ 2

Chapter 1 Introduction ............................................................................................................................... 4

1. Brief Literature .................................................................................................................................. 4

2. Research Question ............................................................................................................................ 6

Chapter 2 Theoretical Framework ............................................................................................................ 7

1. Corporate Governance in Multinational State Owned Enterprise (SOEs) ........................................ 7

2. Internal Mechanism of Corporate Governance in Multinational State Owned Enterprises (SOEs) . 9

3. External Mechanism of Corporate Governance in Multinational State Owned Enterprises (SOEs)12

4. Interaction Effect of Corporate Governance Mechanism ............................................................... 12

5. Multinational SOEs Firm Performance ........................................................................................... 13

Chapter 3 Methodology ............................................................................................................................ 15

1. Data Collection ............................................................................................................................... 15

2. Variables and Measurement ............................................................................................................ 15

3. Empirical Model ............................................................................................................................. 17

Chapter 4 Data Analysis and Results ...................................................................................................... 19

1. Statistical Results ............................................................................................................................ 19

2. Testing the Hypotheses ................................................................................................................... 20

3. Discussion ....................................................................................................................................... 22

4. Conclusion ...................................................................................................................................... 24

Table 1 : Hypotheses ........................................................................................................................................ 17

Table 2 : Descriptive Statistics......................................................................................................................... 19

Table 3: Correlation Matrix of the variables .................................................................................................... 20

Table 4: Regression Output ............................................................................................................................. 21

Table 5: Output Analysis ................................................................................................................................. 22

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Chapter 1 Introduction

1. Brief Literature

Multinational corporations are recognized as the primary actors in the international

business and global economies. Mostly in the developed country, many State Owned

Enterprises (SOEs) jump from a national-based corporation into Multinational Corporation.

Some of those enterprises have chased overseas listings, some have entered into joint ventures

or firm contract with overseas companies, and others have expanded abroad through Merger &

Acquisitions, Greenfield investment or other forms of outbound direct investment (ODI).

Recently, many governments of the developing country also want to transform their SOEs into

Multinational Corporation. The rapidest growth of the Multinational SOEs happened in China

in recent years, which undoubtedly is still an emerging market. The first primary push factor for

‘going global’ of those Chinese SOEs is the central government’s policy and related incentives.

Following this phenomenon, many governments in other developing country have a goal to

transform their SOEs into the multinational enterprise.

Becoming Multinational Corporation is not an easy thing; several obstacles must be

facing such as the policy and knowledge constraint. Corporate governance is one of policy that

government, as SOEs shareholder, can influence in order to develop SOEs into a global scale

corporation. Having good corporate governance is one of the specifications for a company to be

a success in developing their business because corporate governance can reduce the agency

problem, which is a worldwide issue in every form of corporation.

Agency problems appear within a firm when managers have the incentive to reach their

interests at the shareholders’ expense. SOEs seem to suffer more severe agency problems than

private companies. SOEs are the company that was owned and controlled by government

agencies far removed from all citizens (including employees), this situation makes the

motivation for SOEs managers and employees to improve performance is not going maximize

because they can hardly get benefit from individually (Peng 2009). Furthermore, they will

experience “common agency” problem (Siqueira & Cauley, 2009) because they are supervised

by several levels of government, for example by a local government that owns them and the

sovereign state, or by both the state and minority shareholders with potentially have different

interest.

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Several corporate governance mechanisms can reduce agency problems and also

increase firm performance (Agrawal and Knoeber 1996). The internal mechanism of corporate

governance encompasses the controlling mechanism between various actors inside the firm;

these mechanisms include oversight of management, independent internal audits, the board of

directors’ composition, and control and policy development. Moreover, the external control

mechanism is controlled by those outside an organization and serves the objectives of entities,

such as administrators, governments, trade unions and financial institutions (Al-Malkawi and

Pillai, 2012). These two mechanisms work together in a system to affect governance in firms.

Many SOEs today have become multinational in terms of the number of national

markets they serve, the number of countries in which they own or control producing facilities,

the foreign employee they have and even in ownership. Becoming global scale companies, the

governance of those SOEs also has fundamentally changed. Multinational SOEs must establish

and execute a larger number of governance mechanisms and instruments to cope with

globalizing needs and cross-country differences in governance norms. There is a concept “one

size doesn’t fit all”, which is not every company will be better if they implemented the same

corporate governance mechanism. According to Aguilera et al. (2003), the effectiveness of

corporate governance mechanisms depends on critical environmental variables. The firm

characteristic may imply different corporate governance mechanism choices, which explains

why the effect of corporate governance factors on firm performance varies from one study to

the other.

Corporate governance mechanism is a highly studied topic as far as private firms are

concerned, but has received little awareness in the context of Multinational SOEs; this study

contributes to our understanding of corporate governance mechanisms in multinational SOEs.

Realizing the effect of internal and external mechanisms and the model of corporate governance

among the Multinational SOEs will provide valuable information to top policy makers and

assist the government in the restructuring and making a policy of Multinational SOEs.

Consequently, this study also analyze the interaction effect between internal and

external mechanism of corporate governance which is can add the substance about how far

those mechanisms is complement each other or on the contrary substitute each other in

Multinational SOEs.

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2. Research Question

This study will answer the research questions below:

a) Do internal mechanisms of corporate governance affect Multinational State-Owned

Enterprise financial performance?

b) Do external mechanisms of corporate governance affect Multinational State-Owned

Enterprise financial performance?

c) Does an interaction effect between internal and external mechanism of corporate

governance affect Multinational State-Owned Enterprise financial performance?

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Chapter 2 Theoretical Framework

1. Corporate Governance in Multinational State Owned Enterprise (SOEs)

The state sectors have always been an important component of most economies in every

country. Recently, they progressively compete with private firms for resources, ideas, and

consumers in both domestic and international markets (Kowalski, P., et al., 2013). There are

two conservative explanations for the existence of SOEs, the one is SOEs as an economic one

that centers on the solution for market imperfections and the other SOEs as a political one that

focuses on the ideology and political strategy of government officials regarding the ownership

of particular productive assets (Cuervo-Cazurra, Inkpen et al. 2014). SOEs performance always

has a significant influence on country revenue and expenditure. In revenue side, SOEs have a

contribution to tax and non-tax revenue. Furthermore, if SOEs have the poor performance, it

will contribute to state expenditure. Because of those reasons, SOEs must have excellent

performance related to their function to serve public generally.

Furthermore, several SOEs are among the largest and fastest expanding multinational

companies. Multinational corporation governance views if openness to trade and investment can

create substantial economic gains for their business and the economy as a whole, by giving

access to better knowledge and cheaper resources, more efficient specialization and accelerating

competitive pressures that raise productivity (Kowalski et al., 2013). These benefits are believed

will give the same effect for state-owned businesses and may be an important driver for a recent

significant expansion of SOEs into international markets.

Wong (2004) explained if most of SOEs have governance weaknesses, one of them is

agency problem that lead to an increment of government intervention in SOEs governance.

Otherwise, the right of SOEs managers which is to supervise the company always being abused

because most of the managers of SOEs were chosen based on political interest and that lead the

manager has a dependence on government. This governance weakness makes the SOEs

performance less competitive than another private firm.

The core of modern corporate governance is the Agency Problem between outside

shareholders and inside managers. According to agency problem theory from Jensen and

Meckling (2006), there is asymmetric information between agent (in this case is CEO of SOEs)

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which has more inside information about company position than principal (in this case are

society as tax-payer that is represented by government). Another problem appears as a conflict

of interest happened because of the agent will not always perform in the best interest of the

principal, this thing occurs due to both parties to the relationship are utility maximizer. To solve

this agency problem, the company must endure some agency cost. Consequently, administrators

establish governance and control mechanisms to prevent agents from acting opportunistically.

The principal can restrict those interest distinctions by creating appropriate incentives for the

agent and by incurring monitoring cost designed to limit the digression activities of the agent.

Corporate governance covers the way of organizing ownership, management, and control of

a corporation (Hinterhuber, Matzler et al. 2004). According to the definition of the OECD

(Organization for Economic Cooperation and Development, 2004, p.11), “Corporate

governance involves a set of relationships between a company’s management, its board, its

shareholders and other stakeholders. Corporate governance also provides the structure through

which the objectives of the company are set, and the means of attaining those objectives and

monitoring performance are determined”.

A study by Lins (2004), corporate governance mechanisms can be classified into two

categories. The first is particular sets of controls for a corporation come from its internal

mechanisms that observe the progress and activities of the organization and take corrective

actions when the business goes off track. An internal mechanism of corporate governance

involves various actors inside the firm. The next is an external control mechanism that are

controlled by those outside an organization (Al-Malkawi and Pillai 2012).

Recently, most SOEs jump from a local scale corporation into the multinational level.

Multinational corporations are enterprises that have a network owned of producing, marketing

or R&D affiliates located in some countries (Pathak 1989). There are some reasons why SOEs

may be progressively expanding into foreign markets, several of them relating to government

policies and some to internal factors concerning these firms as well as dynamics of markets in

which SOEs operate (Kowalski 2013). Luo (2007) stated if corporate governance in

multinational companies differs from that in domestic firms. Multinational corporations face

heterogeneous corporate governance standards institutionalized by different countries

throughout the world. Furthermore, the governance of SOEs will be critical to ensure their

positive contribution to a country’s overall economic efficiency and competitiveness. As state

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owned enterprises become more globalized, they require more attention to develop their

corporate governance mechanism due to the need to fulfill various stakeholder interests,

involved regulation in the host country and home country government materiality.

2. Internal Mechanism of Corporate Governance in Multinational State Owned Enterprises

(SOEs)

Internal mechanisms of corporate governance is the way of companies to conduct a

monitoring mechanisms between various actors inside the firm: the firm’s management, its

board, and the shareholders (Booth, Cornett et al. 2002). The research that conducted by Choi

and Dow (2008) and Rashid and Islam (2008) use board size and CEO duality as tools for the

internal mechanism of corporate governance. Board size and CEO duality are two important

keys of internal corporate governance that influence the firm’s decisions to the other

stakeholders especially on Multinational SOEs, it happens because culture and political action

are related to these variables (Tanoos, 2013).

a. Board Composition

Recently, the fundamental trend in SOE governance has been to enlighten the roles of

the state, ownership entities, boards and management (Frederick, 2011). The most

prominent governance mechanism that can make and impact on the manager performance is

the board of directors, whose charge is to represent the shareholders. The board of directors

is the ultimate decision making institute of a corporate firm. The members of the Board of

Directors are elected by shareholders, and the shareholders delegate the power that is

accountable to them.

The board of director in SOEs handles the performance of the SOE. Its duty is to ensure

that the SOEs achieves the strategic objectives as contracted with the line minister while at

the same time reaching its commercial goals. The Board also has authority to remove

executive directors, decide about CEO compensation and give approval to major strategic

decisions and firm’s capital structure like stock repurchases or new debt issues, that is why

they are necessary for internal mechanism of corporate governance to monitor and

discipline management (Baysinger and Hoskisson 1990).

Although have same aspects in their structure and functioning, boards of directors in

Multinational SOEs usually do not participate in the same activities they undertake in

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private companies. At best, Multinational SOEs’ boards may act as a kind of organization

body that represents the interests of employees, several ministries, and in some cases, non-

state shareholders. The Organization for Economic Co-operation and Development (OECD)

Guidelines on Corporate Governance of State-Owned Enterprises propose a board is

charged by the state with observing the development of a strategy to achieve the state’s

objectives and monitoring of progress. Related to political influence, the presence of

politicians on the board in SOEs is guaranteed by the direct and indirect control of the firm.

Politicians might assist the firm in reaching a higher economic result by predicting the

government’s actions or when the firm’s revenues rely on the political process, as in the

case of agreements with public institutions.

Based on a new study by Governance Metrics International (GMI) Ratings for Wall

Street Journal 2014, bigger is not always better in the boardroom. Eisenberg, Sundgren et al.

(1998) also explained if there is negative relationship between board size and firm

performance, this condition is driven by the effect of board size in coordination,

communication, and decision making process. As the board becomes larger, there are more

conflicts of interest in decision making because most board members also become passive

and lazy denying on their duties to provide resources (Jensen, 1993). Yermack (1996) also

found that firms with small boards have increased the quality of monitoring and decision

making by the board of directors. Small boards are more likely to retire CEOs for poor

performance that this threat declines significantly as boards grow in numbers. This

condition leads to the first hypothesis in this study.

H1: There is negative relationship between Board Size and Firm Performance

b. CEO Duality

A Chief Executive Officer (CEO) is the highest-ranking executive in charge of the total

management of a corporation. The CEO is responsible for the success or failure of the

corporate. Mostly, the CEO provides the company's operating plan and projected budget

with the guidance and approval of the board, and then CEO will making a report to a board

of directors. The CEO cannot refuse board requests unless they are illegal or violate the

corporation bylaws. The appearance of CEO on Multinational SOEs is crucial because the

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executives must choose their objectives carefully to emphasize the urgency and plow

through the bureaucratic inertia that’s common in state enterprises.

Furthermore, in the board composition there is chairman of the board that is the most

influential member of the board of directors who conducts leadership to the firm's officers

and executives. Generally, chairman is elected by board of directors at board meeting and

shareholder meeting, but mostly in SOEs both chairman and CEO will be appointed by the

government. Different from CEO, chairman typically utilizes substantial power in setting

the board's agenda and deciding the outcome of votes, but chairman does not necessarily

play an active role in everyday management.

There is one condition when those two most powerful positions in the company, the

chairman of the board and the CEO, are combined and held by one person which is called

CEO Duality (Daily and Dalton 1992). CEO duality is chosen for the second internal

mechanism of corporate governance in this study. CEO duality is an important subject in

corporate governance because the status condition of the CEO and chairman may have an

effect on firm performance. Once the same person holds the CEO and the chairman of the

board position together, he or she could use the authority as a board chair to choose the

directors that preferred which are usually the people who are in favor of him or her and less

likely to stimulate his or her decisions (Peng, Zhang et al. 2007).

The question of whether the CEO can also be the chairman of the Board of Directors is

regarded very differentially internationally. According to organization theory, that CEO

duality establishes strong, unambiguous stimulates leadership. But according to agency

theory, this condition will enhance CEO deficiency by reducing board monitoring

effectiveness (Finkelstein and D'aveni 1994).

Furthermore, the key findings from Sanders and Mason (1998) suggest that

multinational companies are more likely to detached the positions of chairman of the board

and CEO, rather than combine them into one position. Separating the two positions in

multinational companies allows for greater dimensions of expertise and information than

would be possible if one person held both positions. Kiel and Nicholson (2003) also found a

negative relationship between CEO duality and firm performance. That series of research

make the second hypothesis.

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H2: There is negative relationship between CEO Duality and Firm Performance

3. External Mechanism of Corporate Governance in Multinational State Owned Enterprises

(SOEs)

The external mechanism involves the outsiders of the company; debt policy is used as a

corporate governance mechanism to reduce agency conflict (Jensen and Meckling 1976, Faccio,

Lang et al. 2001). Bank financing is getting more necessary for Multinational SOEs as

government budgetary grants played a less and less important role (Cull, 2000). The

government as a shareholder and/or CEO and board director of the firms may influence the

chosen of bank debt as a part of the capital structure on Multinational SOEs.

Jensen and Meckling (1976) stated that debt cause a bonding mechanism for the managers

to bring good results for the shareholders, by not creating an opportunity to diverge from the

corporations’ free cash flow. The larger the loans, the more cash the firms will have to pay for

the interest and installment. Debt that taking by the managers will cause risks to the company if

the managers fail to perform an effectively (Dharmastuti and Wahyudi 2013). Thus, the debt

will shift management’s monitoring from shareholders to creditors. This monitoring forces the

management or shareholders to conduct actions that can give benefit to the firm.

Moreover, the announcement of a bank credit agreement conveys the positive news to the

stock market about creditor’s worthiness. Fama (1985) found if bank lenders have a

comparative advantage in reducing information costs and getting access to information not

otherwise publicly available. Bank debts may be value-enhancing for borrowers if the lenders

provide monitoring functions for the borrowing firms, especially when the company has weak

internal governance structures. From that information, the third hypothesis of this study states

bank debt as an external mechanism of corporate governance will enhance firm performance

(Uchida 2008).

H3: There is positive relationship between Bank Debt and Firm Performance

4. Interaction Effect of Corporate Governance Mechanism

Interaction effect happens when the impact of one variable depends on the level of the other

variable. The asymmetric information between shareholder, manager, and debt holder will lead

to the interaction effect between internal and external mechanism of corporate governance.

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This asymmetric information comprises the prospect of the company and manager effort. The

future of the company is reflected by more investment opportunity given that is detected by the

investor through external funding in the capital structure of the enterprise. Otherwise, Pecking

Order Theory that was developed by Myers and Majluf (1984) explained if manager prefer to

use retained earnings (internal funding) when it comes to capital structure and after that

manager will choose debt or equity (external funding) as a last resort.

According to Ranti (2013), the large board size has difficulty in achieving a consensus in

decision which will affect the quality of corporate governance and will translate into higher

external debt levels to enhance firm value. The company value will be increasing because the

debt will give signal to the investor, which is the higher of debt that company owned so the

manager more ensure if the company has brighter future than the company who has lower in

debt financing, and it will give positive influence to the company stock price. Furthermore,

Fosberg (2004) and Abor (2007) argued if CEO duality will increase firm’s debt usage. The

duality leadership will reduce the problem related to separation of ownership and control, so the

CEO duality companies will have high accessibility to external financing (Ranti, 2013). Those

explanations establish fourth and fifth hypothesis of this study which is if there is an interaction

effect between internal and external mechanism of corporate governance.

H4: There is positive interaction effect between Board Size and Bank Debt into Firm

Performance

H5: There is positive interaction effect between CEO Duality and Bank Debt into Firm

Performance

5. Multinational SOEs Firm Performance

Every corporate have the same goal that is to enhance firm performance. Economic

performance is one of dimension goals of Multinational SOEs beside of social performance

(Aharoni, 1981). The Global Investor Opinion Survey on 2002 that is released by McKinsey &

Company found that investors state they still locate corporate governance on a par with

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financial indicators when evaluating investment decisions and more than 60% of the

respondents would pay premium for well-governed companies. Previous studies (Agrawal and

Knoeber 1996, Klapper and Love 2004, Cremers 2005) have established a positive relationship

between good corporate governance and coporate performance. Moreover, Mitton (2000) found

if the variables related to corporate governance had a significant association on firm

performance during the East Asian financial crisis of 1997-1998. Gompers et al. (2003) also

found the positive result between corporate governance indexes with long-term corporate

performance.

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Chapter 3 Methodology

1. Data Collection

According to He (2010), a multinational SOEs is a multinational enterprise with at least 10

percent of state ownership. This 10-percent cutoff is high enough that the state should have the

ability to influence corporate governance and, therefore, firm performance. The study that was

conducted by Cuervo-Cazurra, Inkpen et al. (2014) showed that there are 49 largest non-

financial multinational SOEs in 2010 which divided into government as a majority shareholder

and government as a minority shareholder. Those companies will be used as sample in this

research, and the period that will be used is from the 2010-2013 year period. The period has

been selected because the Multinational SOEs is having a significant increase after the global

financial crisis in 2008.

The data that be used in this research are a combination of time series and cross-section

data. This study uses secondary data for total asset, board size, CEO duality, debt to total assets

ratio, and ROA that have been taken from published company annual reports, especially on

Corporate Governance session. This research also uses the data that is provided by ORBIS and

COMPUSTAT database. The firm with incomplete and inconsistent data will be excluded from

this research.

2. Variables and Measurement

a. Independent Variable and Measurement

For the empirical evidence on the influence of corporate governance mechanism on

firm performance, quantitative research needs to be done. In this study, the independent

variables are board size, CEO duality, and bank debt.

Board size will be measured by the total number of directors (Board size). This research

will use the logarithm of board size, as do previous studies which show that the relationship

between board size and performance is convex rather than linear (Yermack 1996).

Furthermore, CEO duality is a dummy variable for the purpose of analysis. If CEO duality

is identified for one company, a dummy variable is defined as “1”, and if the functions of

CEO and the chairman of the board are separated, then a dummy variable is coded as “0”.

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For bank debt will be measured by the total bank debt to total assets ratio. All of that

information has been taken from the company annual reports.

b. Dependent Variable and Measurement

The dependent variable that is used in this study is financial firm performance. The

study held by Ramdani (2010) evaluated firm performance by using the average value of

return on assets (ROA). ROA apparently takes into account the assets used to support

business activities. It determines whether the company able to generate a sufficient return on

these assets rather than merely showing a robust return on sales. Using ROA as an important

performance metric quickly focuses management attention on the assets required to run the

business, this prediction is in line with the study of the corporate governance which is

focusing on how good is the management in one company. The higher the ROA number, the

better, because the company is earning more money on less investment. Using ROA, it can

be known if management's most important job is to make important decisions in allocating

its resources. Every management can make a profit by using the money to solve the

problem, but just very good management outplay at making large profits with little

investment. This study uses the ROA value for each company in the particular period from

the ORBIS database.

c. Interaction Effect and Measurement

When an interaction effect is provided, the impact of one variable depends on the

level of the other variable. This study will measure the two-way interaction effect between

bank debt into board size and CEO duality, and also the relationship between those

interactions into ROA. In order to examine this interaction effect, this study will generate

new variables such as Board Size – Bank Debt and CEO Duality – Bank Debt.

d. Control Variable and Measurement

It is not possible that corporate governance mechanism will be the only variable that

influences firm performance. Another factor will influence firm performance as well. For

this purpose the size of the company has been selected, because it could be an important

factor that affects how corporate governance mechanisms influence the firm performance.

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Pervan and Jossipa (2012) found if there is a positive relationship between firm size and

firms’ performance. Firm size is proxied by the logarithm of total assets of the firm (Braun

and Sharma 2007).

The summary of hypotheses can be shown in this table:

Table 1 : Hypotheses

Hypotheses Independent Variable Relationship

H1 Board Size Negative

H2 CEO Duality Negative

H3 Bank Debt Positive

H4 Interaction Effect of Board Size and Bank Debt Positive

H5 Interaction Effect of CEO Duality and Bank Debt Positive

Figure 1 : Conceptual Framework

3. Empirical Model

Based on a combination of cross-sectional and time-series data, panel data regression

techniques were used to analyze the performance of the firms. The software that will be used to

make regression analysis is STATA 13.

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Panel data are data for multiple entities in which entity is observed at more than one period

(Stock and Watson 2007). The number of units in a panel data set is denoted by n, and the

number of time period is denoted by T. In this research data set, we will have observations on

n=49 Multinational SOEs and T=4 years from 2010-2013 period. Thus there is a total estimated

of n x T = 49 x 4 = 196 observations.

For the first three hypotheses, this research will modeling the relationship between

dependent variable and one independent variable, so in this case the model that will be used is

linear regression model. The equation model is mentioned below:

Yit = β0 + β1Xit + Uit t = 1, 2, ....., T ; i = 1, 2, ….., n.

Where Yit is the dependent variable, β0 is an intercept, β1 is the slope of the population

regression line, and Xit is the independent variable, and Uit is the error term.

Hypotheses 1 until hypotheses 3 will be tested by linear regression model as mentioned below:

Yit = α + β1CZit + β2BZit ++ β3CDit + β4BDit +Uit

An interaction occurs when the dimension of the effect of one independent variable on a

dependent variable varies as a function of a second independent variable. The regression

equation used to analyze and interpret a 2-way interaction is:

Where is:

Yit : Financial firm performance in company i on year of t that will be proxied by

ROA

β0 : Intercept

Czit : Company size in company i in the year of t that will be proxied by the

logarithm of total asset

BZit : board size in company i in the year of t that will be proxied by the number of

people on the board

CDit : CEO duality in company i on year of t that will be proxied by dummy variable

which is 1 if there is CEO duality and 0 if not

BDit : bank debt in company i in the year of t that will be proxied by total bank debt

to total assets ratio

BZit BDit : the new variable for investigate two-way interaction effect of board size and

bank debt in company i in the year of t

CDit BDit : the new variable for investigate two-way interaction effect of CEO duality

and bank debt in company i in the year of t

Yit = β0 + β1CZit +β2BZit + β3CDit + β4BDit + β24 BZit BDit + β34 CDit BDit + Uit

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Chapter 4 Data Analysis and Results

1. Statistical Results

The descriptive summary is presented in Table 2. From this table, it can be seen if

most Multinational SOEs employ the no CEO Duality structure (147 observations) than CEO

Duality (49 Observations). For board size variable, it can be seen if the means of the board

size for this sample is around 12 people that sit on the board. The bank debt variable

indicating if the multinational SOEs maintain their leverage ratio because the means of this

variable is just around 13% for this sample, it proves if SOEs investment was financed

mainly from interest-free budgetary grants and retained profits. Banks were not really

important a source of funds (Cull, 2000). There is also vary on Multinational SOEs financial

performance which is the mean is only 6.57% that implying if most of multinational SOEs is

still underperformance.

Table 2 : Descriptive Statistics

Variable Definition Descriptive

Statistic

Multinational

SOEs

Dependent

Variable ROA

The return on assets is an accounting

measure of profitability and efficiency,

this variable being defined as earnings

before interest and tax (EBIT) divided

by total assets (book value).

Min -0.0687

Max 0.9258

Mean 0.0657

Stdev 0.1083

Independent

Variable:

Internal

Mechanism of

Corporate

Governance

Board

Size

The total number of directors in one

period in one company

Min 5

Max 22

Mean 11.77

Stdev 3.612

CEO

Duality

The condition when the two most

powerful positions in the company. the

chairman of the board and the CEO are

combined and held by one person

Number of CEO

Duality 49

Number of

NonCEO Duality

147

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Variable Definition Descriptive

Statistic

Multinational

SOEs

Independent

Variable:

External

Mechanism of

Corporate

Governance

Bank

Debt The total bank debt to asset ratio

Min 0.0000863

Max 0.5388

Mean 0.1349

Stdev 0.1265

N 196

The correlation between variables is presented in Table 3. Correlations measure the

strength and direction of the linear relationship between the two variables. From this table, it

can be seen if Bank Debt variable and Log Total Assets has the higher correlation than the

other variables.

Table 3: Correlation Matrix of the variables

ROA Log Total Assets Log Board Size CEO Duality Bank Debt

ROA 1.0000 0.1879 -0.0885 -0.1211 -0.1717

Log Total Assets 0.1879 1.0000 0.1262 0.2855 -0.3187

Log Board Size -0.0885 0.1262 1.0000 0.2302 0.1956

CEO Duality -0.1211 0.2855 0.2302 1.0000 -0.0496

Bank Debt -0.1717 -0.3187 0.1956 -0.0496 1.0000

2. Testing the Hypotheses

The first thing that have must be done before doing the estimation and comparing the

coefficient signal is to determine what linear regression model that suitable for this study.

Chow test and Hausman test has been done for choose the regression model that is used.

From those test, the use of Random Effect Model for overall samples gives a more

significant result for this study. In a random effects model, the unobserved variables are

assumed to be uncorrelated with all the observed variables. Below is the output of regression

coefficient estimation.

21

Table 4: Regression Output

Variable Model 1:

Control Variable

Model 2:

Independent Variable

Model 3:

Interaction Effect

Log Total Assets 0.0311

(0.0245)

0.0285

(0.0283)

0.0241

(0.0285)

Log Board Size -0.0781

(0.0983)

-0.1228

(0.1476)

CEO Duality -0.0185

(0.0206)

-0.0411*

(0.0244)

Bank Debt -0.1626*

(0.0837)

-0.3411

(0.6911)

Log Board Size – Bank Debt 0.1416

(0.6227)

CEO Duality – Bank Debt 0.2292**

(0.1097)

R2 0.0353 0.0699 0.0688

Table 4: Results of random effect model regression of panel data of Log Total Assets, Log Board Size, CEO Duality, Bank

Debt, Log Board Size – Bank Debt, and CEO Duality – Bank Debt on ROA. Standard Errors are displayed in brackets.

Significant at levels:

* p<0.10

** p<0.05

If the variable has p-value < α it comes to significant influence, on the other hand if the p-

value > α so the variable has no significant influence. Based on p-value from each coefficient

variable, it can be known how each independent variable influence into a dependent variable.

From the table above, there is none independent variable that has a significant influence on

the dependent variable.

Using 90% and 95% of confidence level, it can be seen if some variables have not

significant result such as Log Total Assets, Log Board Size, and the interaction between

Board Size and Bank Debt. On the other hand, the variables like CEO Duality, Bank Debt

and the interaction effect between CEO Duality and Bank Debt have a significant

relationship with the ROA.

22

3. Discussion

Table 5 summarizes the hypothesis and the result of this study. From the table, it can be

seen the prediction that is made in hypothesis and the result after doing the regression.

Table 5: Output Analysis

Relationship Between Corporate Governance and Firm Performance in Multinational SOEs

Independent Variable Prediction Result

Internal

Mechanism

Board Size - -

Not significant

CEO Duality - -

Significant

External

Mechanism Bank Debt +

-

Significant

Interaction

Effect

Board Size –Bank Debt + +

Not Significant

CEO Duality – Bank Debt + +

Significant

a. Internal Mechanism of Corporate Governance

The internal mechanism of corporate governance is the way of companies to

conduct a monitoring mechanism between various actors inside the firm. On this study,

the proxies of this mechanism are the logarithm of board director size and CEO duality

that corporate had. The hypothesis of this study stated if small number of board director

size and the non-CEO duality can enhance the firm performance that would be

represented by corporate ROA.

From the second model regression output, it shows if there are no significant

relationships between those variables with firm performance. But when the simultaneous

regression is utilized with the interaction variables, the result show if CEO Duality has a

significant negative relationship with ROA. This implies if the ROA is higher if there is

no CEO Duality on the firm. This finding is in line with the study by Sanders and Mason

(1998) if Multinational SOE have greater dimensions of expertise and information with

implementing the no CEO Duality than if there is one person held two position as

chairman and CEO. This condition will lead to higher firm performance for Multinational

SOEs because the variety of information, knowledge, and expertise are needed for

Multinational SOEs as a global competitive advantage.

23

This result does not support the first hypothesis but supports the second

hypothesis of this study. It can indicate if internal mechanisms have an effect on financial

firm performance in Multinational SOEs.

b. External Mechanism of Corporate Governance

Moreover, the regression result for the external mechanism of corporate

governance rejected the third hypothesis of this study. Instead of having a positive

relationship, bank debt ratio has significant negative relationship into ROA, implying that

ROA is lower in the high bank debt ratio firm. This relationship happened because bank

debt as monitored debt reduces some agency costs but introduces other expenses

(Anderson & Makhija, 1999). One of these costs may related to the risk management of

government, because of debt on Multinational SOEs can become a contingent liability for

Government, and so if corporate fail to pay their debts, the Government is usually obliged

to make the payments and it will lead to high political risk, so the result is the firm will

maintain their leverage ratio to avoid that risk. Moreover, the multinational SOEs also

face differing tax incentives and legal regimes around the world, making them possible to

identify the impact of several factors on financing choices on their capital structure.

External debt is more costly in environments in which creditor rights are weak and

locally available external debt is scarce (Desai & Hines, 2004). In the end, it can be

concluded if external mechanisms have an effect on financial firm performance in

Multinational SOEs.

c. Interaction Effect on Mechanism of Corporate Governance

Although the interaction effect between Board Size and Bank Debt does not have

a significant relationship with ROA, but the interaction effect between CEO Duality and

Bank Debt have a significant positive relationship with firm performance. This result

supported the fifth hypothesis of this study and indicated if there is an interaction effect

between internal and external mechanism of corporate governance that affect

Multinational State-Owned Enterprise financial performance.

According to Ranti (2013), the duality leadership will reduce the problem related

to separation of ownership and control, so the CEO duality companies will have high

24

accessibility to external financing. Furthermore, Fama (1985) found if bank lenders have

a comparative advantage in reducing information costs and getting access to information

not otherwise publicly available, this condition will enhance the performance of the firm.

Multinational SOEs that have CEO Duality will employ more external debt to their

capital structure that less costly than issued the equity, this condition will lead to higher

financial firm performance.

4. Conclusion

There is a broad literature that covers many aspects of corporate governance mechanisms

in order to alleviate the agency conflicts, such as board of director composition, managerial

incentives, capital structure, corporate regulations, and market for corporate control. Using

non-financial Multinational SOEs between 2010 and 2013 period, this study investigates if

the internal mechanism and external mechanism of corporate governance affect firm financial

performance in Multinational SOEs, and this study also want to analyze if there is interaction

effect between those mechanisms that will affect to financial firm performance in

Multinational SOEs.

Evidence from this study found if the internal mechanisms (CEO Duality) and external

mechanisms (Bank Debt) of corporate governance have an impact to the firm financial

performance (ROA) in Multinational SOEs. CEO Duality has a significant negative

relationship to ROA due to Multinational SOEs need the greater dimensions of expertise and

information by applying the no CEO Duality. Moreover, bank debt has significant negative

relationship to the ROA because for Multinational SOEs the high leverage ratio leads to the

higher political risk for the government, as shareholder, so to achieve the good firm

performance the Multinational SOEs will maintain their leverage ratio to avoid that risk.

This study also found if there is an interaction effect between internal (CEO Duality) and

external (Bank Debt) mechanisms of corporate governance that have the positive impact on

financial firm performance (ROA) in Multinational SOEs. The positive interaction effect

between CEO Duality and Bank Debt that have influence to ROA confirms the fifth

hypothesis of this study, this result indicate if the position of CEO and Chairman is held by

one person it will increase the external debt usage and lead to higher performance for the

25

corporate. This finding affirms if the internal and external of corporate governance

mechanism is completing each other instead of eliminating or substituting each other.

The findings of this study add insight for both theoretical understanding and corporate

governance practices; also it found the connections to the performance and behavior of

Multinational SOEs. The result also offered the optimal corporate governance mechanism to

Multinational SOEs with the lower bank debt will lead to higher financial performance of the

firm and CEO Duality can be good for the leveraged firm. This study also implies the

government as shareholder and administrator should be careful not to design strict ‘one size

fits all’ corporate governance rules, they must consider the SOEs that will be or already had

internationally system have different corporate governance atmosphere compare to other

state owned enterprise and other multinational private firm.

In general, there are two main limitations to this study. First, the number of observations

is small because the main focus of this study is multinational companies that have the state as

their owner (Multinational State Owned Enterprises). The number of this type of company

still fewer than the number of the multinational corporations or the state owned enterprise

itself, this happened because Multinational SOEs is a new phenomenon in international

business. Second, the result are not generalizable for all Multinational SOEs, because this

study just use the non-financial Multinational SOEs and exclude the financial companies

since the samples follow the research that has been done by Cuervo-Cazurra, Inkpen et al.

(2014).

The suggestions for the further study are involving the other variables as internal and

external mechanisms of corporate governance and examine similar relations in the

comparable non-SOEs corporation.

26

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Appendix

List of Multinational SOEs

Multinational SOEs Industry Country

1 Petroleo Brasileiro SA Natural resources Brazil

2 Vale SA Mining Brazil

3 CITIC Diversified China

4 China Ocean Shipping Transportation, Shipping and storage China

5 China National Petroleum Natural resources China

6 Sinochem Group Natural resources China

7 China National Offshore Oil Corp. Natural resources China

8 China Railway Construction Corporation Construction China

9 China Minmetals Corp. Natural resources China

10 Lenovo Group Electrical and electronic equipment China

11 ZTE Corporation Telecommunications China

12 TPV Technology Limited Wholesale trade China

13 China Resources Enterprises Natural resources HK/China

14 First Pacific Company Limited Electrical and electronic equipment HK/China

15 Électricité de France Utilities France

16 GDF Suez Utilities France

17 France Telecom Telecommunications France

18 Veolia Environnement SA Electricity, gas and water France

19 Renault Automobile France

20 Volkswagen Group Automobile Germany

21 Deutsche Telekom AG Telecommunications Germany

22 Deutsche Post Transportation, shipping and storage Germany

23 Oil and Natural Gas Corporation Natural resources India

24 Tata Steel Ltd. Metal and metal products India

25 EnelSpA Electricity, gas and water Italy

26 Eni Group Natural resources Italy

27 Japan Tobacco Inc. Food/processing Japan

28 Zain Telecommunications Kuwait

29 Agility Public Warehousing Company Construction and real estate Kuwait

30 Petroliam Nasional Berhad (Petronas) Natural resources Malaysia

31 Axiata Telecommunications Malaysia

32 Sime Darby Berhad Diversified Malaysia

33 Statoil AS Natural resources Norway

34 Qatar Telecom Telecommunications Qatar

35 VimpelCom Telecommunications Russian

36 Singapore Telecommunications Ltd. Telecommunications Singapore

32

Multinational SOEs Industry Country

37 Neptune Orient Lines Ltd. Transport and Storage Singapore

38 Capital and Limited Construction and real estate Singapore

39 MTN Group Limited Telecommunications South Africa

40 Sasol Limited Chemicals South Africa

41 Steinhoff International Holdings Diversified South Africa

42 Sappi Limited Wood and paper products South Africa

43 Vattenfall AB Electricity, gas and water Sweden

44 TeliaSonera AB Telecommunications Sweden

45 Eads Defense The Netherlands

46 Abu Dhabi National Energy Company Utilities UAE

47 DP World Limited Transport and Storage UAE

48 General Motors Automobile USA

49 Petróleos de Venezuela SA Natural resources Venezuela