BOARD COMPOSITION AND STRUCTURE MODEL (MODEL 1d)

Model 1d tests the effects of the relationship between board composition and structure variables on firms’ financial distress. In the model, eleven board composition and structure variables together with the control variables are tested. First, the results indicate that the coefficient of board size is significant but has a positive (b = 0.101, p < 0.05) relationship with financial distress which means that the size of the board of directors has a direct influence on firms’ financial distress. The results mean that H1awhich states that board size is negatively related to firms’ financial distress is not supported. This finding is consistent with the results of Simpson and Gleason (1999), Lajili and Zéghal (2010) Lakshan and Wijekoon (2012) and Ciampi (2015) who establish board size to have a direct influence on firms financial distress. The result is, however, not consistent with Gales and Kesner (1994), Brédart (2014) and Manzaneque et al. (2016). The result means that board size has a direct effect on firms’ financial distress and that the more directors a firm has on its board the more likely the firm becomes financially distressed and vice versa. The Code (2016) requires the board to be of sufficient size but warns that the size must not be so large as to be unmanageable, thus supporting the result that board size should not be large. This is because a large board consumes more pecuniary and non- pecuniary resources in the form of remuneration and perquisites. This significant and positive result supports the agency theory that requires the size of the board of directors to be of a smaller size for its monitoring role though a small board may be influenced by the CEO and may lack the resources to effectively monitor management. Contrarily, both the resource dependency theory and the stakeholder theory, which argue for large boards because large boards bring more varied resources and competences and allow for the representation of different stakeholders of the firm (Gaur et al. 2015), is not supported. Second, the coefficient of the proportion of independent directors indicates that it is significant but has a positive relationship (b = 1.787, p < 0.01) with financial distress. This means that H1b, which states that the proportion of independent directors is negatively related to firms’ financial distress, is not supported. The result is consistent with Chaganti et al. (1985) and Simpson and Gleason (1999), Lajili and Zéghal (2010) and Brédart (2014), who find that the proportion of independent directors is positively associated with the likelihood of financial distress. The result, however, is inconsistent with that of Elloumi and Gueyié (2001), Daily et al. (2003) and (Xiaolan et al. 2006). This result could be attributed to the fact that the firms’ board of directors have included more independent directors to respond to the shareholder or regulatory pressures (Lajili

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and Zéghal 2010). This is because the Code (2016) requires large companies to have at least half the board apart from the chairperson to consist of non-executive directors determined to be independent by the board. Theoretically, apart from the stewardship theory which argues that the presence of independent directors increases the chances of a conflict within the board, the agency, resource dependence, and stakeholder theories are not supported by the result. For instance, the agency theory argues that more independent directors due to their non-affiliation with the firm are in a better position to monitor and control potential opportunism and avoid the selfish behaviours of management. However, Chaganti et al. (1985) who found the proportion of independent directors to be insignificant argue that many independent directors representing different interests may reduce the economic flexibility of the firm resulting in conflicts between the board and top management. The resource dependence theory regards more independent directors as strategic resources who could broaden the firms’ knowledge base, as well as develop links with other firms’ directors but this is not supported by the results. From the stakeholder theory, large independent directors could serve the interest of many stakeholders which could consequently improve performance through improved demand. The results from model 1d however, do not support the stakeholder argument.

Third, on the variable board gender diversity, the coefficient in model 1d indicates that it is insignificant (b = -0.126, p > 0.1). This means that H1c,which states that board gender diversity is negatively related to firms’ financial distress, is not confirmed. Even though the evidence of the effects of board gender diversity on financial distress is lacking, the result is consistent with Appiah (2013) who find that board gender diversity does not impact on the likelihood of corporate failure. This result from model 1d could be attributed to firms not including women on their boards despite the code’s recommendation. Theoretically, no single theory predicts the link between female directors and financial distress. However, it is expected that the inclusion of female directors on firms’ boards would improve their links with other resources outside the firm and broaden the resource base, as well as bringing discipline in the boardroom for effective monitoring, which could improve performance to reduce the likelihood of financial distress for the benefit of all stakeholders. These expected theoretical benefits are not supported by the result. The stewardship theory, however, regards the monitoring role of the board as unnecessary and that management, including female(s), must be empowered to be responsible for the firms’ success to benefit all stakeholder groups, and thus, supporting the result.

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Fourth, the results in model 1d further show that board activity is significantly and negatively (b = -0.210, p < 0.01) associated with financial distress. This result confirms H1d, which states that board activity is negatively related to firms’ financial distress. The result means that the more boards meet to discuss issues, the less likelihood of the firms becoming financially distressed. This is because the ever-changing business climate may require directors to meet frequently to identify and discuss any risks facing the firm and to take strategic decisions to manage those risks to enhance performance that may subsequently reduce financial distress. Moreover, directors in poorly performing firms are under pressure to turn things around and may subsequently hold more meetings. The result of board activity in the models is consistent with the study by Vafeas (1999) who find that firms respond to a poor performance by increasing their level of board activity which in turn is linked with improved operating performance in subsequent years. Theoretically, this result supports the arguments of the agency, resource dependence, and stakeholder theories. Directors’ monitoring responsibility is enhanced (agency theory) when they give more time which a significant resource is (resource dependence) to attend board meetings to discuss firms’ strategic issues for the benefits and interest of all the stakeholder groups (stakeholder theory).

Fifth, board member educational qualification is another variable in model 1d which is found to be significantly and negatively (b = -0.232, p < 0.01) related to financial distress. This result implies that H1e, which states that board member educational qualification is negatively related to firms’ financial distress, is supported. This result means that firms are in a good position to avoid financial distress when board members’ have the required educational qualification. Due to the limited evidence on the effects of board member education on financial distress possibly because of limited disclosure (Christy et al. 2013), the result is not supported by studies on financial distress. The result is therefore compared with studies relating to firm performance. On that basis, the result is in line with that of Christy et al. (2013) who find that professional and formal industry degree qualifications on the board are associated with shareholders’ risk assessment. Theoretically, the agency theory, which argues that board members with the right qualification perform their monitoring and advisory roles better and are critical of firms’ financial reporting strategy, is supported. Board members’ qualification serves as a significant resource for firms’ strategic policies, analysis, and development such that the concerns of different stakeholder groups are dealt with, thus, confirming both the resource dependence and the stakeholder theories.

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Sixth, for board member financial expertise, the results show that it has a significant but a positive (b = 0.468, p < 0.01) relationship with financial distress and this means that H1f is not supported. This result implies that firms with more financial experts are more likely to be financially distressed and vice versa. Financial experts due to their expertise in business management, financial accounting, and reporting are expected to monitor and advise management on value maximising decisions to ensure improved financial performance and avoid the likelihood of financial distress. However, the result in model 1d means that though financial experts are significant they have a direct influence on financial distress and this could be as the results of the fact that financial experts demand higher salary and benefits which could have a financial burden on firms’ operational costs and influence their likelihood of financial distress.

Seventh, for the variable audit committee size, the result in model 1d shows that it has a significant and positive relationship (b = 0.534, p<0.01) with financial distress. Though the result is significant, the positive direction of the coefficient means that H1h, which states that audit committee size is negatively associated with firms’ financial distress, is not confirmed. This relationship means that firms with large size of the audit committee are more likely to be financially distressed and vice versa. The positive association of audit committee size is not in line with the negative association of Platt and Platt (2012), Appiah (2013), and the significance of the coefficient is also not in line with Salloum et al. (2014). This result could be due to the code’s provision that requires large firms to have at least three independent directors, giving firms the opportunity to have audit committees members as they deemed fit. For instance, from the descriptive statistics, some firms have nine members on their audit committees. The large audit committee size means that the effectiveness of audit committees in monitoring management could be affected since they may lose concentration and become less participative. Secondly, meeting the minimum standard does not by itself assure the effectiveness of the audit committee to avoid financial distress since factors such as the level of commitment of audit committee members, quality of discussions during meetings, and organisational work environment may have an influence on audit committee performance (Mohid Rahmat et al. 2009). Theoretically, the agency theory is supported since it requires small audit committees to fulfil their monitoring role for firms to avoid financial distress. However, the resource dependence theory is not supported due to its requirement that large audit committee is needed to bring a diversity of views, expertise, experiences, and skills to ensure effective monitoring to avoid financial distress. Likewise, the stakeholder

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theory is not supported because it argues for large audit committees to monitor and oversee the financial reporting process for the benefits of all the stakeholder groups. Eighth, the coefficient of the variable the presence of a firm’s chairperson on the audit committee is significant and has a negative relationship (b = -0.357, p < 0.1) with financial distress, meaning firms with their chairpersons being members on the audit committees are less likely to be financially distressed. This result means that H1k, which states that the presence of a firm’s chairperson on the audit committee is positively associated with firms’ financial distress, is not confirmed. The code requires the chairperson to be independent at the time of appointment as chairperson but must not chair the audit committee if he/she becomes a member of the audit committee. This removes any influence and conflict of interest that the chairperson would have on the committee. Although, a firm’s chairperson with his/her knowledge of the firm is a valuable resource that enhances the monitoring as well as ensuring the quality and transparency of the financial reporting process of the audit committee, his/her knowledge of the firm’s operation could affect the committee’s performance and consequently affecting financial performance. Hence, the direct relationship is not supported by the result.

Nineth, the result in model 1d further indicates that the remuneration committee size is significantly and negatively (b = -0.475, p < 0.01) related to firms’ financial distress. This result means that H1i, which states that the remuneration committee size is negatively associated with firms’ financial distress is supported. This remuneration committee size result is in line with Chan et al. (2016) who find that the size of a remuneration committee significantly predicts corporate failure, but inconsistent with the result of Appiah and Chizema (2015). This result means that at least three independent directors on the remuneration committee are required to perform its responsibilities of determining the appropriate remuneration packages for directors. This result does not support the arguments of the agency theory which requires small remuneration committee size to have an effective decision on directors remuneration as well as monitor management’s operations. However, the resource dependence and the stakeholder theories which argue for large remuneration committee size are supported because, with large remuneration committee size, firms can have directors with varied qualifications and skills as well as establishing the link with external sources of resources. Large remuneration committee size provides the number of directors who can stand for the different groups of stakeholders. Tenth, for the coefficient the presence of a firm’s chairperson on the remuneration committee in model 1d, the results indicate that it is insignificant but

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negatively (-0.185, p > 0.1) related to financial distress. This means that H1j, which states that the presence of a firm’s chairperson on the remuneration committee is negatively related to firms’ financial distress, is not supported. This result could mean that the firm’s chairperson is not needed in the remuneration committee to determine executives and non-executives remuneration packages since according to Anderson and Bizjak (2003), total compensation levels show only a marginal relation to the CEO’s presence on the remuneration committee.

Eleventh, the coefficient of the variable audit committee independence in model 1d shows that it has a significant and negative relationship (b = -0.0110, p < 0.05) with financial distress. The result means that H1g, which states that audit committee independence is negatively associated with firms’ financial distress, is supported. The result is in line with that of Carcello and Neal (2003), Platt and Platt (2012) and Miglani et al. (2015b) but inconsistent with Mohid Rahmat et al. (2009) and Salloum et al. (2014) who find that audit committee independence is not negatively related to the probability of financial distress. This evidence of the study means that the audit committee with its fully independent members is a significant resource for effective monitoring, giving assurance to financial reports to improve market performance for all the stakeholder groups (Bronson et al. 2009). The results of audit committee independence, therefore, support the monitoring (agency theory), resource provision (resource dependence theory), and stakeholder groups benefits (stakeholder theory). Finally, for the control variables in model 1d, the results indicate that the significance and the direction of the control variable remain the same as model 1a.

In conclusion, when model 1d and model 1a are compared, model 1d has the best fit than model 1a since the AIC arithmetic value of model 1d of 1758.92 is lower than that of model 1a which is 1926.14. Again, the pseudo r-square and the log pseudolikelihood of model 1d which are 0.2066 and -864.46 respectively, and that of model 1a which are 0.1325 and -959.07 show that model 1d predicts financial distress better than model 1a. This means that although a model with the financial variables can predict firms’ financial distress, the inclusion of the board composition and structure mechanisms improves the model which implies that firms must ensure that having those board composition and structure variables is not just to follow the principles of the code but acknowledge that using them effectively prevent the firms from financial distress.

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