Firm Performance

Corporate financial performance can be measured by different methods. However, prior corporate finance literature has not provided a consensus way with regard to the choice of corporate financial performance measure. For example, prior empirical literature can be classified for three main streams. First, there are empirical studies that based only on accounting profitability measures, see for example; (Morck et al., 1988; Cao, Pan, & Tian, 2011; Hu & Zhou, 2008). Another strand of literature uses both accounting profitability and market based performance measures including (Anderson & Reeb, 2003; Guest, 2009; Li et al., 2015; Wahba, 2015; García- Meca et al., 2015; Carter et al., 2010; King & Santor, 2008;Jalbert, Rao, & Jalbert, 2011; Maury, 2006). Other studies have relied only on market based performance measures including (Himmelberg et al., 1999; Berthelot et al., 2010;Nguyen et al., 2015;Jermias & Gani, 2014; Shan & McIver, 2011; Yang & Zhao, 2014).

It is a worthy noting that prior literature has demonstrated advantages and disadvantages for all performance metrics. For example, accounting profitability measures i.e., ROA and ROE are backward-looking measures, and can be easily affected by accountability and managerial transparency (Demsetz & Villalonga, 2001). However, Return on Assets (ROA) can provide business owners and top-level management with effective tool to measure the effectiveness of their predetermined goals. Additionally, accounting profitability measures can provide banker, investors, and financial analysts with an overall picture about a firm’s financial resources utilization and financial strength (Corinna et al., 2013).

On the other hand, market-based performance measures i.e., Tobin’s Q is one of the most frequent measure that prior empirical literature has relied on to assess a company performance. According to Demsetz & Villalonga, (2001) Tobin’s Q is a forward-looking performance measure, and it reflects the market growth and expectations, which in terms has been the most favoured methods for economists, who have better understanding of the market rather than accounting constraints to assess a firm’s financial performance. However, Tobin’s Q has been criticized recently by scholars arguing that it can be confounded by certain practices that may lower the

Average Q, these practices are directly to the managerial behaviour of underinvestment.40

40 _{For example Dybvig & Warachka,(2012) claim that Tobin’s Q doesn’t measure corporate financial performance,}

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Nonetheless, this research will mainly depend on Tobin’s Q ratio to capture a firm performance in this analysis. However, it should be noted that for robustness checks and sensitivity analysis of the main findings, an alternative performance (ROA & ROE) indicators will be employed as dependent variables instead of the main indicator (Tobin’s Q). As stated above, these measures are the most frequent used performance metrics in prior related empirical literature. According to Haniffa & Hudaib, (2006) the use of alternative performance measures can enhance the research results robustness. Below discussion is more analysis about the performance indicators used in this research and methods applied to calculate each one of them.

4.5.1.1 Tobin’s Q Ratio

As stated above, Tobin’s Q is one of the dominant form of evaluation methods that has been widely used in corporate governance literature. According to Abraham, (2013) the use of Tobin’s

Q in literature which is motivated by the insights that firms generated rate of return greater than the required rate of return and will usually command market valuation premium relative to its book value or replacement cost. Tobin’s Q usually defined as the market value of equity divided by replacement cost. Contemporaneously, firms with higher Tobin’s Q can be considered to be more favourably viewed by the market. In some cases, market replacement costs are not provided and are very difficult to obtain. To overcome this problem (Chung & Pruitt, 1994) proposed a simple estimator that requires a basic accounting ratios to estimate Tobin’s Q for a performance measurement.

Thus, due to the difficulties and lack of required information to calculate replacement costs in the Jordanian context, following Nguyen et al., (2015), Doidge et al., (2001) among others, this study will adopt the below formula to execute Tobin’s Q calculations:

𝑄𝑖𝑡 =

𝑀𝑉𝐸𝑖𝑡 + (𝑇𝐴𝑖𝑡 − 𝑇𝐸𝑖𝑡)

𝑇𝐴𝑖𝑡 Eq. (2)

Where 𝑄_𝑖𝑡 = Tobin’s q for the ith firm at t period of time. 𝑀𝑉𝐸 𝑖𝑡 = the market value of equity of the ith firm at t period of time, calculated as the firm’s year-end closing stock price times

the firm’s number of common stock outstanding. 𝑇𝐸 𝑖𝑡 = total shareholders’ equity for the ith firm at t point of time. And finally, 𝑇𝐴 𝑖𝑡 = is the book value of total assets for the ith firm at t point of time.

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This performance indicator (i.e., Tobin’s Q) is employed in this research to better explain the diverse country- and firm-level corporate governance mechanisms impact on market value of the firms listed in small emerging markets such as Jordan and the UAE, which may gain comparative insights on the effectiveness of variant corporate governance mechanisms adopted by nonfinancial firms listed in these two different emerging markets.

4.5.1.2 ROA and ROE

It’s indeed that, the researcher is fully aware of corporate financial performance that can be measured from different perspectives. The above method provides market expectations perspectives, whereas, the accounting profitability ratios provide historical perspectives. The

Return on Assets (ROA) and the Return on Equity (ROE) are the methods that will be used in this research to capture the historical perspectives of the non-financial firms’ performance in Jordan. While the ROA shows how efficient a firm’s management is to generate earnings from its assets, the ROE illustrates how much profit a firm can be generated from the shareholder’s equity that has been invested in the firm.

The ROA can be simply calculated by dividing a firm’s net income by the book value of its total assets. On the other hand, Return on Equity (ROE) is another popular way to measure corporate financial performance. It can be calculated by dividing a firm’s net income by its shareholders’ equity. Corporate finance literature has highlighted ROE as one of the best methods to test financial performance as long as debt levels which are rational. Accordingly, the ROE can be inflated by increasing the leverage level in a firm as ROE can be an output of the (ROA * leverage multiplier) (Corinna et al., 2013).

It is worth noting that, each study examines financial performance that may suffers from issues. One common issue that is identified in prior corporate finance literature is the presence of outliers. Outliers can be described as an extreme values (abnormal observations) that might be positive or negative which may affect results robustness and may distort the research analysis (Black et al., 2012; Gupta et al., 2013). Prior academic literature has suggested two main methods to deal with this issue. One way is to exclude these extreme values from the analysis41.

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Nonetheless, removing these extreme figures may reduce the total number of the observations which in terms affect the research sample and hence, loss of information (Liu et al., 2012).

Another way to eliminate the potential effect of the outliers is called winsorizing. This is an alternative method that would be applied in this research instead of excluding abnormal observations in the corporate performance data. Data winsorization means replacing the abnormal observations in a data set with a certain percentile value from each end. In this research, corporate financial performance variables (Tobin’s Q, ROA and ROE) will be censored at the 1st and the 99th percentiles.42 Next section, sets the corporate governance and firm performance variables measurements.