The Control Variables: Firm Characteristics

This study employed a number of control variables to reduce potential omitted variables bias (Ntim et al., 2012a and b). These variables are firm size (FSZ), firm growth (SGR), leverage (LVG), capital expenditure (CEXC), Dividends (DV), industry dummies (INDU) and year dummies (YDU). Table 5.2 shows definitions and how control variables are measured. The variables were chosen based on theoretical expectation, and are in line with previous empirical studies examining the relationship among corporate governance, voluntary corporate governance disclosure and firm performance. Arguably, there may be other variables that can influence voluntary corporate governance disclosure and financial

performance, which are not included in the used model. More precisely, there are three reasons for limiting the study to these variables: (i) some variables lack a theoretical link with voluntary corporate governance disclosure and financial performance; (ii) non- availability of data, which limits the use of other variables; and (iii) it is in line with prior studies that widely use these specific variables, which can facilitate comparison of the findings with those of previous studies.

The next subsection discusses the theoretical basis for selecting the control variables and the empirical evidence from previous studies.

i) Firm Size (FSZ)

Firm size is an important factor influencing good corporate governance practices and firm financial performance (Eisenberg et al., 1998; Samaha et al., 2012). Larger firms have greater agency problems due to the complexity of their capital structure (Jensen and Meckling, 1976; Bebchuk and Weisbach, 2010). Therefore, they are more likely to improve voluntary corporate governance disclosure in order to reduce information asymmetry (Jensen and Meckling, 1976; Eng and Mak, 2003). However, Klapper and Love (2004) argue that smaller firms tend to improve corporate governance practices due to the greater potential for growth and to obtain external financing.

Empirically, prior studies have indicated a positive relationship between firm size and voluntary corporate governance disclosure (e.g., Eng and Mak, 2003; Alsaeed, 2006; Omar and Simon, 2011; Elzahar and Hussainey 2012; Ntim et al., 2012a; Samaha et al., 2012; Allegrini and Greco, 2013). Thus, it is hypothesised that there is a positive relationship between firm size (FSZ), as proxied by the natural log of the book value of a firm’s assets, and corporate governance practices/firm financial performance.

ii) Firm Growth (SGR)

Theoretically, the growth of a firm is accompanied by an increase in its business activities (Henry, 2008). Consequently, growth in firms implies an increased need for external capital (Beiner et al., 2006; Chung and Zhang, 2011). To reduce financing costs, growing firms may need to improve their corporate governance practices (Klapper and Love, 2004; Bozec et al., 2010). Furthermore, the growth of a firm is usually accompanied by the presence of a good management team and an active board of directors that attracts potential investors (Chen, 2011). Those investors may demand an increase in voluntary corporate governance disclosure to protect their investments (Eng and Mak, 2003; Allegrini and Greco, 2013).

Empirically, existing studies support the above argument and find a positive and significant relationship among firm growth, voluntary corporate governance disclosure and firm performance (e.g., Gompers et al., 2003; Haniffa and Hudaib, 2006; Henry, 2008; Laidroo, 2009; Ntim and Soobaroyen, 2013). Therefore, it is hypothesised that the relationship between firm growth (SGR), as proxied by the growth of sales, and corporate governance disclosure/firm performance is expected to be positive.

iii) Leverage (LVG)

Agency theory suggests that a higher level of debt raises the ‘free cash flows’ that may increase the agency problem (Jensen,1986). Haniffa and Cooke (2002) argue that firms’ existing debt may help the board of directors in their monitoring role. More precisely, banks prefer to lend to firms that have high levels of accountability and transparency. Similarly, borrowing firms may seek to increase their disclosure and enhance transparency to reduce financing costs (Klapper and Love, 2004; Bozec et al., 2010). Thus, firms with higher leverage are more likely to disclose corporate governance information to legitimise their actions to creditors (Ntim and Soobaroyen, 2013).

Empirical studies find mixed results in examining the relationship between leverage and voluntary corporate governance disclosure. Some studies suggest a positive relationship (e.g., Alsaeed, 2006; Barako et al., 2006; Omar and Simon, 2011). However, other studies find that the impact of leverage on voluntary corporate disclosure is weak (e.g., Ho and Wong, 2001; Haniffa and Cooke, 2002; Akhtaruddin et al., 2009; Ntim et al., 2012a; Samaha et al., 2012; Allegrini and Greco, 2013). Other studies suggest a negative relationship between leverage and firm financial performance (Haniffa and Hudaib, 2006; Jackling and Johl, 2009; Mangena et al., 2012). After looking at the mixed findings, it is hypothesised that there is a statistical relationship between leverage (LVG), as proxied by percentage of the increasing debt used to finance firms’ assets, and voluntary corporate governance disclosure/firm performance.

iv) Capital Expenditure (CEXC)

The corporate governance literature suggests that capital expenditure is related with firm growth (Pfeffer, 1972; Pearce and Zahra, 1992). Because of the existence of firm growth, it appears that there is a need to increase expenditure. This requires more monitoring by the board of directors and enhanced accountability to protect shareholders’ wealth (Nicholson and Kiel, 2007; Conyon and He, 2011). Therefore, theoretically, an

increase in capital expenditure may improve corporate governance practices and firm financial performance.

Empirically, prior literature suggests the existence of a weak relationship between capital expenditure and voluntary corporate governance disclosure (Ntim and Soobaroyen, 2013). On the other hand, mixed findings appear upon examining the relationship between capital expenditure and firm performance. Weir et al. (2002), Hossain et al. (2001) and Haniffa and Hudaib (2006) find a positive relationship between capital expenditure and firm performance. However, Jackling and Johl (2009) and Mangena et al. (2012) find a negative relationship. Thus, it is hypothesised that there is a statistical relationship between capital expenditure (CEXC), as proxied by the percentage of total capital expenditure to total assets, and corporate governance practices/firm financial performance.

v) Dividends (DV)

Adjaoud and Ben-Amar (2010) argue that firms with high dividends may disclose more corporate governance information. Agency and managerial signalling theories provide three forms of empirical support: (i) to justify the payment of compensation, managers of profitable firms may increase disclosure (Ntim and Soobaroyen, 2013); (ii) to display the firm’s financial ability and contribution to society (Ntim et al., 2012a); and (iii) to gain shareholders’ confidence and attract potential investors (Haniffa and Cooke, 2002). Empirically, some corporate governance studies support the positive relationship between dividends and good governance practices (e.g., Archambault and Archambault (2003);

Adjaoud and Ben-Amar (2010). Therefore, it is hypothesised that there is a statistically significant association between dividends and corporate governance practices/firm financial performance. Firm dividends is measured by a dummy variable that takes a value of 1 if a firm paid dividends during the financial year, and 0 otherwise.

vi) Industry Dummies (INDU)

The level of compliance with corporate governance standards and firm performance differs among firms based on industry (Haniffa and Cooke, 2002; Hussainey and Al-Nodel, 2008). This variation can be attributed to differences in financing structure, ownership structure and business nature (Hussainey and Al-Nodel, 2008). Moreover, there is variation in the regulations between industries, where some are subject to additional rules (Tsamenyi

et al., 2007). For example, some firms whose operations have the potential to damage the

environment, such as oil and gas, are obliged to disclose more information about their operations (Arcay and Vazquez, 2005).

Consistent with prior literature (e.g., Haniffa and Cooke, 2002; Barako et al., 2006; Ntim et al., 2012a; Samaha et al., 2012), this study includes industry dummies as control variables to capture potential and unobserved industry type heterogeneity. The designed model includes six industry dummies so that the dummy variable trap could be avoided.

vii) Year Dummies (YDU)

The literature indicates that voluntary corporate governance disclosure and firm performance vary across firms over years (e.g., Conyon, 1994; Haniffa and Hudaib, 2006; Chalevas, 2011). For instance, Conyon conducted a survey of 400 UK listed firms and found firms complied more in some years than others. This positive relationship is supported by Chalevas (2011), who suggests that the level of voluntary corporate governance disclosure among Greek listed firms improved over the four years from 2000 to 2003. Similarly, Ntim et al. (2012a) conduct a study on 169 South African listed firms between 2002 and 2006, and find that compliance with King II is related to time.

Furthermore, the global economy may has an impact on a firm’s voluntary corporate governance disclosure and performance. For example, the profits of many international firms were affected negatively by the economic global recession in 2008. This led them to disclose more about the repercussions of the crisis on their firm’s performance (Mangena et al., 2012). Therefore, year dummy variables are included in the model to capture potential unobserved firm-level heterogeneity over the seven-year period from 2004 to 2010 (e.g., Haniffa and Cooke, 2002; Barako et al., 2006; Ntim et al., 2012a; Samaha et al., 2012). Six year dummy variables are included in the model to avoid the dummy variable trap.

Following prior literature, and assuming that all relations are linear, OLS regression is employed to investigate whether variations in the SCGI are explained or predicted (i.e., to answer the third research sub-question) by the above variables, as follows:

Model 1 it n i it i it it it it it it it it it CONTROLS DONR BONR IONR GONR CGC AFZ BSZ INDD SCGI                      



Where

SCGI The constructed Saudi Corporate Governance Disclosure Index Constant term

INDD Independent directors

BSZ Board size

AFZ Audit firm size

CGC Presence of corporate governance committee

GONR Government ownership

IONR Institutional ownership

BONR Block ownership

DONR Director ownership

CONTROLS Control variables for firm size (FSZ), firm growth (SGR), capital expenditure (CEXC), leverage (LVG), dividends (DV), industry dummies (INDU) and year dummies (YDU)

Error term or residual

The following section describes the details of two models exploring the relationship between corporate governance mechanisms and firm financial performance (i.e., to answer the fourth and fifth research sub-questions).

5.4 CORPORATE GOVERNANCE MECHANISMS AND FIRM FINANCIAL