Development of a Conceptual Framework for This Study

The purpose of this study is to examine current corporate governance practice and explain the implications of this practice on firm performance in the case of listed companies in the UAE. The conceptual framework (see Figure 5.2) illustrates the link between the theoretical framework discussed above and the corporate governance variables and firm performance that are investigated in this study. Evidence in empirical research suggests that several variables influence the relationship between corporate governance practice and firm performance, as discussed in Chapter 3. The conceptual framework involves corporate governance mechanisms and corporate governance principles as independent variables. Some of the dependent variables identified in the corporate governance literature to measure firm performance include ROA, ROE and Tobin’s Q. Firm size and leverage are control variables in this study.

5.4.1Independent variable: corporate governance practice

The present study identifies the corporate governance practice variable on the basis of corporate governance mechanisms and principles. The corporate governance mechanisms referred to here include board size, separate leadership, board composition and audit committee independence. This research uses four corporate governance

mechanisms reported in companies’ annual reports to comply with the code of corporate governance in the UAE, as discussed in Chapter 2. In previous studies (Daily & Dalton, 1994; Barnhart & Roseinstein, 1998; Weir, Laing & McKnight, 2002; Kiel & Nicholson, 2003; Abdullah, 2004; Aggarwal et al., 2009), these corporate governance mechanisms were used to examine the relationship between corporate governance mechanisms and firm performance. The results show that the governance mechanisms listed above affect firm performance and are therefore relevant to the conceptual framework as an influencing factor; this is supported by the agency theory.

The present study develops an index to measure the principles of corporate governance using a survey method to calculate that index based on the OECD Principles of Corporate Governance. These principles consist of the rights of shareholders, equitable treatment of shareholders, role of stakeholders in corporate governance, disclosure and transparency, and board responsibilities, as discussed in Chapter 3. Corporate governance principles have been used in previous research to investigate effects on firm performance (Li & Tang, 2007; Cheung et al., 2011; Dao, 2008; Sunityo-Shauki & Siregar, 2007; Kalezić, 2012). As a result, this study considers that the principles of corporate governance are important in influencing firm performance in the conceptual framework, as supported by the stakeholder theory. This comprehensive framework provides a clear understanding of the role of corporate governance practices in influencing firm performance in the listed companies.

5.4.2Dependent variable: firm performance

The present study considers firm performance a dependent variable and measures it on the basis of accounting measures (ROA and ROE) for the short-term analysis of operating performance, and Tobin’s Q, which is the most widely used long-term proxy for firm valuation. Previous empirical research has used different measures of corporate governance-based firm performance; for instance, Babatunde and Olaniran (2009) utilise ROA and Tobin’s Q as measures of firm performance in 62 firms listed on the Nigerian Stock Exchange. Haat, Rahman and Mahenthiran (2008) provide empirical evidence for the effect of corporate governance practices on firm performance by using ROA and ROE as proxies of performance among a sample of 50 non-finance firms listed on stock exchanges in Pakistan from 2003 to 2005.

Imam and Malik (2007) use Tobin’s Q as the performance measure using data from two samples for 2000 and 2003 from listed companies on the Dhaka Stock Exchange. Heenetigala and Armstrong (2011) investigate the effect of corporate governance practices on firm performance and utilise ROA, ROE and Tobin’s Q to measure performance using data from the annual reports of a sample of 37 companies in Sri Lanka in 2003 and 2007. As Lamport, Seetanah and Sannassee (2011, p. 9) state, ‘there is no agreed consensus on which proxy is the best’. Consequently, the conceptual framework utilises comprehensive measures based on accounting formulas (ROA and ROE) for financial performance, and Tobin’s Q market-to-firm valuation ratio. These are commonly used measures to assess firm performance and have also been used in previous research on corporate governance and firm performance (Sengur, 2011). It is clear from previous discussions that good corporate governance is an important element in enhancing firm performance, as presented in Chapter 4.

5.4.3Control variables

Firm size is used as the control variable in this study because it has been found to be associated with firm performance. For instance, Lehn, Patro and Zhao (2009) report that firm size affects firm performance, and Haniffa and Hudaib (2006) empirically document a significant negative association between firm size and firm performance. However, Aljifri and Moustafa (2007) provide empirical data supporting a positive association between firm size and firm performance. In addition, leverage has been widely used as a control variable in a number of empirical studies. Alsaeed (2006) examines the relationship between corporate governance and a company’s financial performance, revealing that debt negatively affects performance. Mitton (2002) shows that weak corporate governance could correlate with higher debt levels; therefore, poor stock price performance is a recognised leverage factor. The present study uses firm size and leverage as control variables in order to be consistent with prior research, which has investigated the relationship between corporate governance and firm performance (Himmelberg, Hubbard & Palia, 1999; Al-Haddad, Alzurqan & Al-Sufy, 2011). The conceptual framework presented in Figure 5.2 shows that, as controlling variables, firm size and leverage influence corporate governance and firm performance in the listed companies.

Figure 5.2 Conceptual Framework: Corporate Governance and Firm Performance

Corporate governance

Firm performance

The conceptual framework of the current research provides an understanding of how the findings are accurately related to the research questions and hypotheses. It plays a significant role in the explanation or justification of the link between what the study expects and the findings. Section 5.5 presents the research conceptual framework; Section 5.6 presents the development of the research hypotheses.