Equilibrium Variable Model

The equilibrium variable model (EVM) is developed from the argument that there were no mandatory CG provisions for organisations to comply with before the late 1980s. Since the 1980s, there has been an increasing propagation of CG provisions or codes to ensure managers of firms are acting in shareholders’ interest (Danielson and Karpoff, 1998). Thus, before the proliferation of CG codes, internal CG mechanisms were driven by essential court decisions, firms’ specific needs or requirements (e.g. environmental uncertainties, attracting skilled, well-educated and qualified directors and pressure from the owners), legal and business advice, peer industry behaviours etc. (Black, 1992, Danielson and Karpoff, 1998). Hence the EVM assumes that, without CG provisions, internal CG structures like the composition of the board and CEO duality are mainly derived within a firm (Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985). More so, the model assumes that some CG structures are more important than others (Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985, Memon et al., 2012, Mangena et al., 2012, Antwi et al., 2012, Mehran, 1995, Barako et al., 2006).

Second, the EVM assumes there will be varied agency problems across different firms as a result of variability in the ownership structure, size of the firm and other firm- specific idiosyncrasies (Gillan, 2006). Furthermore, external CG structures (e.g. legal and regulatory requirements and market for corporate control) are exogenously derived in such a manner that differences across the external environments in which firms operate may both help increase or decrease the value of a firm (Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985). Last of all, the EVM assumes that the use of specific internal CG mechanisms is not automatically complementary. Thus the use of a particular internal CG mechanism more frequently than others may still equally lead to increase in firm financial performance (Vafeas and Theodorou, 1998, Danielson and Karpoff, 1998, Botosan, 1997, Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985).

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This therefore suggests that there is an optimal mix of internal CG structures which impacts positively on a firm’s financial performance. By this reasoning, a firm will continue to put in place internal CG mechanisms to the point where marginal benefit will be equal to the marginal cost (Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985).

In a nutshell, the EVM assumes an association between the implementation of internal CG mechanisms and firm financial outcomes. As such, it assumes that each firm has an optimal internal CG structure. Consequently, each firm should be able to make choices regarding its internal CG structures without any interference from the outside. Thus firms’ internal CG mechanisms are internally generated (Vafeas and Theodorou, 1998, Danielson and Karpoff, 1998, Botosan, 1997, Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985). Hence a firm will continue to put in place internal CG structures to the point where the cost associated with a marginal increase in its internal governance structure will be lower than an increase in the financial outcomes (i.e. at a point such a firm is in equilibrium in its internal CG structure).

This means for example that, while increase in director and managerial ownership to align the interest of executives with that of shareholders may effectively increase the firm’s financial performance in one firm, it may not necessarily be effective for another firm because of variability in the size of the firm, ownership structure of the firm and other firm-level idiosyncrasies. This is the oldest approach and most popular approach researchers have used to investigate internal CG and firm performance nexus even after the proliferation of good CG codes around the world (Ntim, 2013c, Danielson and Karpoff, 1998, Agrawal and Knoeber, 1996, Demsetz and Lehn, 1985). This model therefore is used to examine research sub-question two: ‘Do endogenously generated alternative firm-level internal corporate governance mechanisms affect firm financial performance in Nigeria and South Africa?’ The EVM for this study is stated as follows:

 Equilibrium Variable Model:

Pit =δ it + β1BSZit + β2 NEDit + β3 INEDit + β4 EDit + β5 GDIVit +

β6EDIVit + β7 DUALit+ β8 GEAR it +β9 FRE-Mit + β10 ILOCKit+ β11

INST-SHit + β12D-SHit + β13 IACit + β14 BNESS it + β15

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Where i=1… 180, t=...5 and Pit is performance measures of ROCE (Return on Capital Employed) and Q-ratio for firm i at time t, β1 to β14 are the vectors of individual internal CG variables, board size (BSZ), non-executive directors (NED), independent non- executive directors (INED), executive directors (ED), gender diversity (GDIV), ethnic diversity (E-DIV), gearing (GEAR), frequency of board meetings (FRE-M), board interlock (ILOCK), institutional shareholding (INST-SH), director shareholding (D- SH), audit committee independence (IAC), board busyness (BNESS) as independent variables plus the control variables (CONTROLS)and Uit isthe error term.

5.3.1.1 Independent Variables for the Equilibrium Variable Model

I. Board size:Measured by the total number of directors who serve on a board.

II. Board structure (proportion of NEDs):A variable which measures percentage of

non-executive directors to total number of directors who serve on a board.

III. Proportion of EDs (Executive Directors): A variable which measures percentage

of executive directors to total number of directors who serve on a board.

IV. Proportion of independent NEDs:A variable which measures percentage of

independent non-executive directors to total number of directors who serve on a board.

V. Frequency of board meetings:A variable which measures number of board annual

meetings.

VI. CEO/Chairman role separation:Measured by a dummy with ‘1’ when the

positions of board chairman and CEO are held by separate individuals and ‘0’ when the positions are held by an individual.

VII. Board gender composition (gender diversity):A variable which measures

percentage of women to total number of directors who serve on a board. VIII. BOD ethnic composition (ethnic diversity):A variable which measures the

percentage of black directors to total number of directors who serve on a particular board.

IX. Interlocking directorates:Measured by average number of boards the directors of

a firm sit on outside the firm.

X. Board busyness: Measured as the average firm-level number of board meetings

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XI. Gearing (debt to equity): A variable which measures total debt, divided by total

equity.

XII. Institutional shareholding:Measured by the percentage of institutional

shareholders and block holders to the total shares of a firm.

XIII. Director shareholding: Measured by the number of shares held by directors (both executive and non-executive) to the total shares of a firm as a percentage.

XIV. Independent audit committee:Percentage of independent non-executive directors

to total number of directors who serve on the audit committee.