Corporate Governance and the performance of firms in Trinidad & Tobago

Corporate Governance and the performance of firms in Trinidad & Tobago Varuna L. Ramlal & Patrick K. Watson SALISES, St. Augustine

Objectives • Construct a Corporate Governance (CG) Index for firms listed on the Trinidad & Tobago Stock Exchange (TTSE) • Examine relationship between CG and performance of TTSE firms • Policy implications & Conclusions

CG defined • Many definitions… • Sir Adrian Cadbury (1992): “Corporate Governance is the system by which companies are directed and controlled.” • Cornelius (2005): “corporate governance can be defined as the stewardship responsibility of corporate directors to provide oversight for the goals and strategies of a company and foster their implementation.”

CG defined cont’d • OECD (2010): corporate governance refers to “procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation – such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision-making.”

CG defined cont’d • Fahy et al (2006): “Put in its simplest form, corporate governance is the systems and processes put in place to direct and control an organisation in order to increase performance and achieve sustainable shareholder value.” • Kaen (2003): “Corporate Governance is about who controls corporations and why”

Assessment of CG • CG is relevant in the marketplace but one of the major concerns of researchers - the measurement of CG • The literature has proposed the use of CG Indices (Ananchotikul 2008, Black et al 2003, Cornelius 2005, Garay and Gonzalez 2008, Klapper and Love 2002, Carvalhal-da-Silva and Leal 2005, Mallin 2006.)

Assessment of CG cont’d • However, most of these indices have two shortcomings – (i) they have been produced for developed countries only and (ii) they rely on questionnaires issued to the firm being assessed. • Researchers have found that when firms are asked to respond to questionnaires they put in what information they think is the ‘right answer’

Assessment of CG cont’d • OR what they intend to do instead of what actually happens in their firm: self-report bias. • OR they may not respond at all: self-selection bias. • For this reason there has been some movement away from reliance on questionnaires administered to firms to use questionnaires which use public information only (Ananchotikul2008, Bebczuk2005, Black et al 2006, Carvalhal-da-Silva and Leal 2005, Cheung et al 2007)

Index creation • Quantitative questionnaire used • Covers major aspects of CG • Board Responsibility • Board Structure • Shareholder Rights • Transparency and Disclosure • Audit Committee

Index creation cont’d • Questions based on the CBTT’s CG Guideline and generally accepted CG procedures. • Yes – 1, No – 0 • Missing values not counted except for Transparency section where the absence of a value is equivalent to a lack of transparency • Final index value weighted to be between 0 and 1 for ease of firm comparison

Index Creation cont’d • Total – 143 questions • Board Responsibility – 38 • Board Structure – 25 • Shareholder Rights – 10 • Transparency & Disclosure – 53 • Audit Committee – 17 • Sub-indices as well as total CG index calculated

Financial Ratios - Performance • Many calculated… • Earnings per share • Price/Earnings • Dividend per share • Dividend yield • Dividend cover • ROA • ROE • Stock return • Share price also used as an indicator

Data • Firms on first and second tier of the TTSE used • Years: 2008, 2009, 2010 • CGITT used as the dependent variable • Ratios – main explanatory variables of interest • Control variables included –age, size

Method of analysis • Dependent variable is the CGITT index and its sub-index values • Due to the nature of the data a fixed effects panel data model was used • This was supported by the use of the Hausman test • CGITTit=Cit+ β1ROAit+ β2STKRETit+ β3EPSit+ β4AGEit+ εit

Results • Summary statistical measures: • Maximum CG value – 0.87 in the year 2010, expected because expect firms to improve CG as they get more familiar with CG requirements • Minimum CG value – 0.209 in 2008, also expected for same reason as above • The average values of the CGITT also show an increase over the years. In 2008 it was 0.56, in 2009 the value was 0.68 and in 2010 it was 0.76

Results cont’d

Results cont’d • The CGITT variable was tested with all the performance indicators as dependent variables. However, only some of the variables were found to be significant.

Results cont’d • Some conflict in the results: operating performance positively affects CG but stock-related measures have dual effects. • Diagnostic checks: • R-squared: 0.7393 • Autocorrelation test: indicates that there is no autocorrelation in the model

Results cont’d • Error term: Kernel Density Graph, plots of normal vs residual

Results cont’d • Sub-indices were also used as dependent variables • Significant values that held up to the diagnostic tests were only found for the Shareholder Rights sub-index • For all other sub-indices the residuals were unable to pass the diagnostic tests

Results cont’d • Shareholder Rights • The results here indicate that an increase in ROA results in a decline in Shareholder Rights and an increase in Age, an increase.

Results cont’d • SR error term: Kernel Density Graph, plots of normal vs residual

Results cont’d • Mixed results: performance increases some types of governance but restricts others • Certain types of performance have different effects on governance • Older firms tend to have better governance

Policy implications & Conclusions • Overall there has been an improvement in CG in Trinidad & Tobago over the three years • This is also true for the sub-indices • Positive result since it shows that firms are becoming more aware of the CG requirements • Should encourage firms to continue to improve governance so there will be less missing values in the index (AC and BS had minimum values of zero)

Policy implications & Conclusions cont’d • Operating performance has a positive effect on overall governance BUT a negative effect on shareholder rights. • Firms should be wary of restricting shareholder rights while boosting profits • Stock performance has a mixed effect on governance

The End

Corporate Governance and the performance of firms in Trinidad & Tobago