Compliance Index Model (CIM)

Contrary to the EVM, which assumes an endogenous generation of internal CG mechanisms, the compliance index model (CIM) assumes that internal CG structures are externally enforced, as such organisations tend to select internal CG structures as a set or bundle (Gillan, 2006, Danielson and Karpoff, 1998). The CIM thus assumes that the financial performance of a firm is likely to be influenced by a collection of internal CG mechanisms derived from CG provisions or codes instituted and backed by statutory legislations. Furthermore, as a result of external influence on internal CG mechanisms, there exists possible interdependence between internal CG structures (Gillan, 2006, Danielson and Karpoff, 1998, Agrawal and Knoeber, 1996). Owing to this possible interdependence of various CG structures, rather than looking at them as individual CG mechanisms often in isolation to each other, the CIM advocates for a construction of compliance index which is based on a set of CG provisions to empirically investigate internal CG and firm financial performance nexus. This model therefore is used to examine research sub-question one: ‘How and in what ways does firm-level compliance with exogenously developed corporate governance provisions impact on firm financial performance in Nigeria and South Africa?’ Following from the preceding argument, the compliance index model is stated as follows:

Compliance Index Model:

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Pit is performance measures of ROCE and Q-ratio for firm i at time t, β is a vector of compliance index (CGI), and CONTROLS represents control variables and Uit isthe

error term.

5.3.2.1 Independent Variables for the Compliance Index Model (CIM)

I. Composite/Integrated Corporate Governance Index (CGI):

Independent variables for the CIM for both countries is represented by the South African Corporate Governance index (SACGI), which is a composition of CG provisions outlined in King III which firms are required to apply or explain reasons for non-application. Similarly, the Nigerian Corporate Governance Index (NICGI) is composed of the provisions of SEC 2011 CG code expected to be complied with by listed firms or reasons given for non-compliance. Consistent with prior research (Ntim, 2013a, Ntim, 2013c, Black et al., 2006), a binary coding scheme is adopted to construct a firm-level compliance index in each country. This involves awarding ‘1’ where a firm complies with an internal CG provision of the country code in the annual report and ‘0’ where it does not. The CG provisions composed in the SACGI (South Africa) and NICGI (Nigeria) are based on provisions of SA (2009) King III and Nigeria’s (2011) CG code. The scoring involves manually reading firms’ annual reports and awarding one point where a firm discloses/complies with/applies a CG provision and zero when it does not. For example, South Africa’s King III report has 84 CG provisions required to be applied by listed firms; thus, a firm’s total compliance score for the year ranges from zero (0%), indicating no compliance, to 84 (100%), indicating full compliance. Similarly, in Nigeria, the NICGI is composed of 75 CG provisions as stated in the SEC 2011 CG code. Therefore, a firm will score between ‘0’ (0%) for non-compliance and 75 (100%) for full compliance.

The CG indices for Nigeria and South Africa are broken down into two indices. One captures provisions aimed to protect shareholder value creation and the other incorporates affirmative country-level stakeholder provisions. These sub-indices are presented below.

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To test hypothesis H10b, an index for shareholder disclosures includes 61 shareholder provisions (shareholder–NICGI) in Nigeria as specified in the SEC 2011 CG code. These disclosures include traditional corporate governance requirements aimed at increasing shareholders’ returns by reducing agency cost. Shareholder provisions scores (shareholder–NICGI) vary from zero (0%) to 61 (100%) in Nigeria. In South Africa, the shareholder–SACGI (shareholder provisions) captures 71 conventional corporate governance provisions borrowed from the Anglo-American CG model with the premise of reducing agency cost and increasing shareholders’ return. Shareholder provisions scores for South Africa (shareholder–SACGI) vary from zero (0%) to 71 (100%).

III. Stakeholder Compliance Index (Stakeholder–NICGI and Stakeholder–SACGI):

On the other hand, to test H10c, the South African Stakeholder–SACGI (stakeholder provisions) have thirteen (13) contextual inclusive actions and stakeholder provisions as stated in King III, whereas the Nigerian stakeholder disclosure requirement

(Stakeholder–NICGI) is composed of fourteen (14) contextual inclusive actions and stakeholder provisions of SEC 2011 CG code. Similarly, the stakeholder provisions score for Nigeria (Stakeholder–NICGI) ranges from zero (0%) to 14 (100%), and in South Africa it ranges from zero (0%) to 13 (100%).

5.3.2.2 Limitation/Choice of Weighted Index (SACGI and NICGI)

The various country CG compliance indices (SACGI and NICGI) are coded using a binary coding scheme and the indices are unweighted. As noted by Barako et al. (2006), Ntim (2009) and Ntim et al. (2012), unweighted indices are not able to capture important groups of requirements as they treat all CG provisions as equal in importance, which may be inconsistent in theory and practice. However, empirical research in CG suggests that weighted and unweighted indices give similar results, especially where CG provisions are large (e.g. Barako et al., 2006, Ntim et al., 2010, Ntim et al., 2012, Ntim, 2013c). Specifically, this study did not use weighted indices as it would have meant some CG provisions are given more weight than others, which would not be an accurate representation of respective country CG regulations. More

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so, the use of an unweighted index in this study is consistent with prior research (Ntim, 2013a, Ntim, 2013c, Black et al., 2006).