Endogeneity and the corporate governance - performance relation

Abstract

The governance-performance literature is characterized by its inability to reach a consensus regarding the nature of the relation. We posit that these inconsistent findings are symptomatic of inadequacies in the econometric techniques employed when adjusting for all forms of endogeneity. To test this, we fit a comprehensive model of performance and governance using a range of econometric techniques. Once a dynamic generalized method of moments (GMM) specification robust to all forms of endogeneity is employed, we observe no causal relation between governance and firm performance, suggesting that apparently significant relations uncovered by pooled ordinary least squares (OLS) and fix-effects models are the result of spurious correlations.

Corporate fraud culture: Re‐examining the corporate governance and performance relation

“…For endogenous variables, the lags of 1 and higher of the differences are available as valid instruments, and the current and lags of differences in the predetermined variables are employed as instruments (Blundell and Bond, 1998;and Roodman, 2009). The lag specification of the internal instruments is consistent with Wintoki et al (2012) and Schultz et al (2010).…”

“…Consistent with Ferguson et al (2011), Schultz et al (2010 and Hutchinson et al (2008), we measure the composition of board of directors, ownership structure, and director and executive remuneration. Our sample period includes the 2003 introduction of the ASX Principles of Good Corporate Governance and Best Practice Recommendations.…”

“…1 Board of Directors (POWER.RATIO; DUALITY; and BOARD.SIZE) Board structure measures focus on the board's independence from management (Hart, 1995;and Borokhovich et al, 1996), measured by the ratio of nonexecutive to executive directors (Schultz et al, 2010) 3 . Further measures include a dummy variable to indicate whether a duality in the roles of the CEO and chairperson exists and the size of the board as a measure of the effectiveness of the board of directors as a monitoring mechanism (Lipton and Lorsch, 1992;and Jensen, 1994).…”

“…Indeed, there is ample research suggesting that corporate governance is an endogenously determined characteristic of the firm (Hermalin and Weisbach, 2003;Brown et al, 2011;and Coles et al, 2012). The dynamic generalised method of moments (GMM) panel models can be applied to the corporate governance and firm performance relation (Pathan and Skully, 2010;Schultz et al, 2010;Pham et al, 2011;and Wintoki et al, 2012) to account for the various forms of endogeneity that may be present 2 .…”

“…firms that have experienced at least one occurrence of fraud) in the period of 2000 to 2007, the corporate governance and firm performance relation is analysed within the dynamic GMM framework that corrects for the influence of unobserved heterogeneity, dynamic endogeneity and simultaneity. This will discern whether adjustments in corporate governance have a significant effect on firm performance for companies that are vulnerable to a corporate culture of fraud, to compare the results from previous studies that have reported no relation between governance and firm performance (Schultz et al, 2010;Pham et al, 2011;and Wintoki et al, 2012).…”