Corporate Governance

Emerald Article: Board structure and ownership in Malaysia: the case of distressed listed companies Shamsul Nahar Abdullah

Article information:
To cite this document: Shamsul Nahar Abdullah, (2006),"Board structure and ownership in Malaysia: the case of distressed listed companies", Corporate Governance, Vol. 6 Iss: 5 pp. 582 - 594 Permanent link to this document: http://dx.doi.org/10.1108/14720700610706072 Downloaded on: 25-05-2012 References: This document contains references to 83 other documents To copy this document: permissions@emeraldinsight.com This document has been downloaded 2165 times.

Access to this document was granted through an Emerald subscription provided by UNIVERSITI PUTRA MALAYSIA For Authors: If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service. Information about how to choose which publication to write for and submission guidelines are available for all. Additional help for authors is available for Emerald subscribers. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.com With over forty years' experience, Emerald Group Publishing is a leading independent publisher of global research with impact in business, society, public policy and education. In total, Emerald publishes over 275 journals and more than 130 book series, as well as an extensive range of online products and services. Emerald is both COUNTER 3 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation.
*Related content and download information correct at time of download.

Board structure and ownership in Malaysia: the case of distressed listed companies
Shamsul Nahar Abdullah

Shamsul Nahar Abdullah is an Associate Professor in the Faculty of Accountancy, Universiti Utara Malaysia, Kedah, Malaysia.

Abstract Purpose This study seeks to examine the inuence of board independence, CEO duality and ownership structure on the rm nancial distressed status using a sample of distressed companies and a matched-pair sample of non-distressed companies listed on the Bursa Malaysia. Design/methodology/approach This study utilized publicly available data from annual reports of a sample of 86 non-nance distressed rms listed on the Bursa Malaysia and a sample of matched 86 non-distressed rms for a period covering the 1999-2001 nancial years. Findings Board independence and CEO duality are not associated with nancial distressed status. Management and non-executive directors interests are associated negatively with nancial distress. A negative association is also documented for outside blockholders. The evidence also supports the contention that ownership by non-executive directors and outside blockholders effectively increases their incentives to monitor management in ensuring their wealth in the rms is intact. Research limitations/implications One limitation of this research is that it relies on publicly available data and agency theory. Future research could apply other theories, such as resource dependency and stewardship. Use of process-oriented data could also improve the ndings. Practical implications Independent directors need to undergo training to help them improve and be aware of their responsibilities. Originality/value This paper offers evidence on the extent to which distress is associated with corporate governance from a developing country. The paper should be of interest to the regulatory bodies and practitioners. Keywords Boards of Directors, Chief executives, Corporate ownership, Financial performance, Corporate governance, Malaysia Paper type Research paper

Introduction
In recent years, criticisms have been targeted at corporate governance especially calling for reforms of the board of directors (Geneen, 1984; Kesner et al., 1986, Lorsch, 1989; Levitt, 1998). The argument is that the board of directors has not discharged its duciary roles effectively. In Asia, in the aftermath of the 1997 nancial crisis, most Asian countries have sought to strengthen the corporate governance, transparency and disclosure levels (Ho and Wong, 2001). This paper seeks to examine whether board structure and ownership structure are associated with nancial distress in Malaysia. The primary contribution of this study is the setting in which it is conducted, in which it examines the role of corporate governance on nancial distress status within an emerging economy. Unlike the previous studies, which were done in North America or the UK, in this emerging economy, it is predicted that the market for corporate control is weak (Mak and Li, 2001). Signicant efforts to improve corporate governance in Malaysia were only seen during the 1997-1998 crisis with the publication of the Report on Corporate Governance in 1999. Furthermore, concentrated shareholdings by individuals and families together with signicant equity holdings by the

PAGE 582

CORPORATE GOVERNANCE

VOL. 6 NO. 5 2006, pp. 582-594, Q Emerald Group Publishing Limited, ISSN 1472-0701

DOI 10.1108/14720700610706072

government are two features that distinguish the ownership patterns of Malaysian companies from companies in the USA or in the UK, which could add complication to the corporate governance. This ownership pattern presents corporate governance issues, particularly ones that involve minority shareholders, that may not be similar to the ones peculiar to companies in those developed countries. In addition, the fact that Chinese and Malays dominate the economics and politics in Malaysia respectively provides a unique research setting that is not found elsewhere. The separation results in the regulators being predominantly Malays and the businesses being owned by the Chinese. Therefore, ndings from this study should add to the understanding of institutional differences, which directly affect the operations of the boards of directors. Shleifer and Vishny (1997, p. 740) state that Most of the available empirical evidence [on corporate governance] . . . comes from the United States . . . Unfortunately, except for the countries just mentioned, there has been extremely little research done on corporate governance around the world . . . Another contribution is that the denition of nancial distress adopted by this study is different than the one used in previous studies (e.g. Elloumi and Gueyie, 2001) where this study adopts the denition of nancial distress as used by the Bursa Malaysia. Companies facing nancial distress are expected to face a number of corporate governance issues, particularly on the issue of directors effectiveness in discharging their monitoring roles. This paper proceeds as follows. In the next section, the theoretical development will be covered, followed by the methodology section. The empirical results will be presented in the subsequent section, followed by the discussion section. Finally, the summary and conclusion section will follow.

Theoretical development
Financial distress and corporate governance Shareholders expect rms to adopt high-risk high-return strategies to maximize the value of the rms. Projects with positive NPVs and with high variance are therefore preferred. These strategies, however, could adversely affect a managers employment in the rm as it could face risk of failure. Managers, unlike shareholders who could diversify their portfolios, have their wealth tied to the rms survival. Instead, managers, seen as risk averse, may engage in activities that reduce the rms risk (Jensen and Meckling, 1976; Amihud and Lev, 1981) through, among others, corporate diversication (Amihud and Lev, 1981). This was actually observed among Malaysian companies in the early and mid-1990s when the Malaysian economy experienced a high economic growth with anual GDP growth of 7-8 percent. During this period, companies were seen to pursue the growth strategies by diversifying their businesses without proper cost-and-benet analysis, which were made possible through easy access to bank loans (Abu-Bakar, 2001). In fact, Mohd-Nasir and Abdullah (2004) reveal that the gearing ratio of the distressed sub-sample was 12 times higher than the gearing ratio of the non-distressed rms. In 1998, a double-digit interest rate was observed and the Malaysian currency depreciated very signicantly against major currencies. These situations had caused companies with high debts, which had been obtained in the mid 1990s, not being able to serve the debts, resulting in a total of 276 Bursa Malaysia listed companies having their non-performing loans taken over by the National Asset Management. It could be argued that had the boards been effective, companies would not have borrowed excessively and thus the risk of nancial distress could have been avoided. The composition of a board of directors and leadership structure serve as a rms internal monitoring mechanisms in a corporate governance process (Walsh and Seward, 1990). In fact, Mizruchi (1983, pp. 432-3) claims that the board of directors is the ultimate center of control of a corporation. Further, being the highest decision-making body in a corporation, the board is accountable for the long-term health and survival of the corporation (Louden, 1982). The association between corporate governance structure and nancial distress exists because nancial distress is not a discrete event, rather it is a late stage of a protracted process of decline and a downward spiral (Hambrick and DAveni, 1988, p. 1). In fact, Daily and

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 583

Dalton (1994b) show that in the year of bankruptcy ling, nancial indicators alone (protability, liquidity and leverage) explain 95.54 percent of their bankruptcy model. Thus, a stronger board, compared to a weaker board, should be able to devise appropriate strategies to correct the downward trends faced by the rm. Staw et al. (1981) further explain that in declining or crisis periods, rms often resort to a mechanistic shift with centralization of authority being the result. Among the dysfunctional aspects of the shift include conservatism, rigidity, questionable escalation, reliance on past policies, increases in centralization and formalization and resistance to change (Staw et al., 1981; Singh, 1986; Cameron et al., 1987; Dutton and Duncan, 1987; Whetten, 1987). Argenti (1986a, b) suggests that corporate failures are associated directly with CEOs, boards of directors and top management members. It is therefore less likely that top management team members and inside directors, who work for the CEO, are able to oversee and control the CEO in times of crisis (Daily and Dalton, 1994a). In fact, studies have had doubts on the boards ineffectiveness in preventing bankruptcy (Gilson, 1990; Hambrick and DAveni, 1992; Gales and Kesner, 1994; Daily and Dalton, 1994a, b; Daily, 1995, 1996). It has been documented also that bankrupt rms lose prestigious top management team members immediately prior to a bankruptcy ling (DAveni, 1990). Another perspective that explains the role of corporate governance on nancial distress is resource dependency (Selznick, 1949; Pfeffer and Salancik, 1978; Burt, 1983) that sees outside directors as a critical link to the external environment. Appointing representatives from signicant outside constituencies as outside directors is viewed as . . . a strategy for managing organizations environmental relationships (Daily and Dalton, 1994b). Thus, these outside directors are expected to play active roles in ensuring rms not to enter into nancial difculty. Board structure Research on corporate governance has predominantly relied on agency theory (Daily et al., 2003). They, however, conclude that evidence of superior shareholders value from the shareholder-oriented perspective is not conclusive. In the literature, it has been shown that the board effectiveness in protecting the shareholders is associated with independence (e.g. Baysinger and Butler, 1985; Kosnik, 1987; Hermalin and Weisbach, 1988; Weisbach, 1988; Kini et al., 1995). Having outside directors is vital as they can act as . . . providers of relevant complementary knowledge to the management (Fama and Jensen, 1983, p. 315). However, evidence of non-executive directors ineffectiveness or even their adverse impacts on the boards monitoring incentives has also been documented with the main concern on the issue of non-executive directors, who are not be truly independent of management (Vicknair et al., 1993; Bhagat and Black, 1997). In a similar vein, Perry (1995) contends that independent non-executive directors may adversely impact the board cohesiveness because they simultaneously play the roles of decision makers and monitors of management, which could lead to a conict of interest. An effective board of directors should have led and monitored companies appropriately and designed the risk management mechanisms to ensure the companies are not exposed to excessive nancial risks that could lead to it becoming nancially distressed. Three characteristics, as argued by Jensen (1993), affect the monitoring potential of a board: board size, board composition and board leadership structure. Empirical evidence generally shows a link between board independence and distressed rms (Daily and Dalton, 1994b; Daily, 1995). In a study involving distressed Canadian companies, Elloumi and Gueyie (2001) show that the percentage of outside directors on the board of directors of distressed rms are signicantly lower than that of the matched healthy rms and board independence negatively inuences the rms nancial healthiness. Chaganti et al. (1985), on the other hand, show that the extent of outside directors between failed and non-failed companies is not signicantly different. Though research evidence is mixed, it is predicted

PAGE 584 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006

that board independence is associated negatively with nancial distress as the theory suggests. It is proposed that: H1. Board independence is negatively associated with nancial distressed status.

Research has shown that the discriminatory power for bankrupt/survivor rms go as far back as ve years prior to the bankruptcy ling (e.g., Aziz et al., 1988; Baldwin and Glezen, 1992; DAveni, 1990; DAveni and MacMillan, 1990; Hambrick and DAveni, 1992). Thus, in times of declining performance, the boards that separate the roles of CEO and chairman are expected to be able to correct the downward spiral more effectively than the boards that combine the top two roles. A CEO who also serves as the board chairman is more likely to . . . use their inuence not to effect change, but to keep the course (Daily and Dalton, 1994b, p. 1605). Evidence by Hambrick and DAveni (1992) supports this contention where they reveal that dominant CEOs are more likely to be related to bankrupt rms. Nevertheless, the substantial costs of the separation could come from . . . the incomplete transfer of company information, and confusion over who is in charge of running the company (Goodwin and Seow, 2000, p. 43). Hence, it could also be argued that when one person is in charge of both tasks, the decisions can be made much faster, especially during the time of crisis. Findings on the link between CEO duality and corporate failures, nevertheless, are mixed. Consistent with Hambrick and DAveni (1992), Daily and Dalton (1994b) nd that rms with the CEO acting as the board chairman are more likely to go bankrupt as opposed to rms that are not. This evidence is reconrmed by Elloumi and Gueyie (2001), who examine rms that are facing nancial difculties but contradicts Chaganti et al.s (1985) evidence. However, in Malaysia, the issue of CEO duality is addressed in details in the Malaysian Code and thus the issue is seen to be important. Accordingly: H2. There is a negative association between CEO duality structure and nancial distressed companies.

Ownership structure The distinctive feature of Malaysian companies is the tightness of ownership where shares are held either by states, families or individuals (Abu-Bakar, 2001). Abdullah and Mohd-Nasir (2004) show that the average shareholdings by the top 20 shareholders are found to be at 73 percent. Any single largest shareholder has been found to hold, on average, 36 percent of the rms shares (Abdullah, 2001). Agency theory argues that shareholdings by management would reduce agency costs (Jensen and Meckling, 1976). Thus, this would reduce the likelihood of their rms becoming distressed. Nonetheless, excessive management shareholdings could lead to management entrenchment. Fama and Jensen (1983) postulate that rms that are controlled by management are less likely to survive in competition. The ndings by Morck et al. (1988) and McConnell and Servaes (1990) reveal a curvilinear relationship between management interest and a rms value and support this contention. For Malaysian companies, anecdotal evidence by Abu-Bakar (2001) seems to suggest that the relation between management interest and distress is negative, supporting McConnell and Servaes (1990) evidence. According to McConnell and Servaes (1990), within a range of 5-25 percent for management interest, the association between management interest and rms value is positive. Thus, management interest is predicted to be negatively associated with nancial distress. The hypothesis is as follows: H3. Management interests are negatively associated with nancial distress.

The extent to which non-executive directors hold shares in the rms is associated with their intensity in monitoring management and in ensuring management pursues value-increasing activities (Beatty and Zajac, 1994). It is argued that non-executive directors incentives lead to greater boards monitoring management or involvement in strategy development and implementation (Kesner, 1987; Oswald and Jahera, 1991; Shivdasani and Yermack, 1999).

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 585

Hambrick and Jackson (2000) further show that the extent of non-executive directors interests not only help to create incentives but also make them more associated with the company, resulting in them being more involved in their oversight and more generous in their time and attention. Jensen and Meckling (1976) argue that substantial shareholdings by outside directors should provide greater incentives for them to monitor top management. Further, Jensen (1993, p. 864) contends that encouraging outside board members to hold substantial equity interests would provide better incentive to monitor the management. Thus, it is predicted that the interests of non-executive directors are negatively associated with nancial distress. The hypothesis is therefore as follows: H4. Non-executive directors interests are negatively associated with nancial distress.

Large shareholders could limit agency problems (Shleifer and Vishny, 1986; Admati et al., 1994; Noe, 2002). Kang and Shivdasani (1995) also show that the large shareholders lead to an increased management turnover. Thus, interests by outsiders are predicted to play important roles in determining the nancial distressed status, more importantly those who own a large percentage of shares. Furthermore, these outside blockholders have their wealth tied to the nancial performance of the rms, and are therefore predicted to invest their money in companies that are nancially healthy. The hypothesis is thus as follows: H5. The extent of outside blockholders interests is negatively associated with nancial distressed companies.

Methodology
In this study, nancial distressed companies are dened as those that are classied in the Bursa Malaysia PN4 sector. Following the 1997 crisis, the Bursa Malaysia issued the Practice Note 4 in 2001, which outlines the criteria used by the Bursa Malaysia to identify companies that are required to regularize their nancial conditions. Failure to regularize their nancial conditions within the stipulated time results the company being de-listed. The deadline given to these companies was 31 December, 2002. Four criteria have been outlined by the Bursa Malaysia, and the fulllment of at least one criteria results in the company being referred as an affected listed issuer: 1. decit in the adjusted shareholders equity; 2. appointment of receivers and/or managers over the property of the listed issuers; 3. adverse opinions or disclaimers in respect of the going concern form the auditor; or 4. appointment of special administrators pursuant to the provisions of the Pengurusan Danaharta Nasional Berhad Act 1998. The Bursa Malaysia implemented PN4 classication in 2002. The decision on categorizing a rm into PN4 is made by Bursa Malaysia if the listed rm fullls one of the above criteria. Trading of shares of these affected companies is either suspended or restricted. Vanhorne (1971) describes two situations of corporate failure: technical insolvency and insolvency in bankruptcy. A company is said to face technical insolvency when it is unable to meet its current obligations and insolvency in bankruptcy occurs when a companys net worth is negative. Thus, based on the denition, Bursa Malaysia PN4 companies fall under insolvency in bankruptcy. According to Wruck (1990), a company enters into nancial distress following economic distress, decline of performance or poor management. As at 31 December, 2002, a total of 86 companies were classied under the Bursa Malaysia PN4 sector, after excluding nance companies. A matched company for each PN4 company was determined on three bases: Bursa Malaysia sectorial classication, similar total assets and positive EPS throughout the period of study. The nancial years that this study was interested in were the periods prior to the PN4 classication introduced by the Bursa Malaysia but after the crisis, i.e. 1999-2001.

PAGE 586 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006

To test the hypotheses, the pooled logistic regression analysis was carried out, which is as follows: STATUSit a b1 YR1 b2 YR2 b3 BDINDit b4 DUALITYit b5 MGTit b6 NEDit b7 OUTBLKit b8 ACINDit 1it : where: i: t: STATUS: YR1: YR2: BDIND: DUALITY: MOWN: rm 1 through 86; year 1999 through 2001; 1 if distress, 0 otherwise; 1 if nancial year 1999, 0 otherwise; 1 if nancial year 2000, 0 otherwise; percentage of independent directors on the board; 1 if the board chairman and CEO roles are combined, 0 otherwise; percentage of shares held by executive directors;

NEDOWN: percentage of shares held by non-executive directors; OUTBLK: ACIND: cumulative percentage of shares outside shareholders holding 5 percent or more of shares; and 1 if all audit committee members are independent directors; 0 otherwise.

Audit committee independence is included in the regression model as one of the control variables. Carcello and Neal (2000) examine nancially distressed companies and they nd a negative relation between the extent of inside or afliated directors on the audit committee and the likelihood of that rm being given a new going-concern report. In another paper, Carcello and Neal (2003) show a direct association between the proportion of inside and afliated directors on the audit committee and the likelihood of a rm changing external auditors after being given a going-concern report. In the present study, audit committee independence is treated as a dummy variable with value 1 being given if all the members are independent directors. This is motivated by the Sarbanes-Oxley Act of 2002 (Section 301) (US Congress, 2002), which requires rms to maintain audit committees whose members are all independent.

Results
Out of 86 non-nance companies that were in the Bursa Malaysia PN4 sector as at 31 December, 2002, four companies were excluded due to change in nancial year ends and data unavailability. As a result, a total of 504 rm years were available for the pooled analysis (1999: 170, 2000: 170, 2001: 164). Results of the descriptive statistics and the t-tests are shown in Table I. Results in Table I support all the selection criteria used in choosing the matched companies. Results in Table I also show that distressed rms have a lower liquidity ratio as opposed to non-distressed rms and the latters liquidity ratio is ve times higher than the formers. Thus, the gearing and liquidity ratios are associated with distressed rms, supporting the evidence among bankrupt and non-bankrupt companies (e.g. Altman, 1968; Platt and Platt, 2002). The earnings per share (EPS) of the distressed sub-sample is signicantly negative compared to the EPS of non-distressed rms, which is signicantly positive. An analysis also indicates that the EPS of distressed sub-sample has been negative since the 1998 nancial year (1998: 2RM1.54, 1999: 2RM1.4, 2000: 2RM0.82, 2001: 2 RM0.76). This evidence thus suggests that these rms have started to experience nancial difculty immediately after the 1997 crisis. Table II shows the results from the pooled logistic regression analysis. Results in Table II show that the inuence of years (i.e. 1999, 2000 and 2001) is not signicant. As for hypothesis testing, results in Table III suggest that H1 is not supported. In Model 2 of Table II,

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 587

Table I T-test results (distressed 252 rm years, healthy 252 rm years)

Variables Earnings per share (in cents) Distressed Healthy All rms Total assets (000) Distressed Healthy All rms Board independence (BDIND) Distressed Healthy All rms CEO duality (DUAL) Distressed Healthy All rms Executive directors interest (MGMT) Distressed Healthy All rms Non-executive directors interest (NED) Distressed Healthy All rms Outside blockholding (OUTBLK) Distressed Healthy All rms Audit committee independence (ACIND) Distressed Healthy All rms Liquidity (LIQDTY) Distressed Healthy All rms Gearing (GRG) Distressed Healthy All rms Mean Std dev. T-value ( p-value)

20.99 0.26 20.35 480,115 678,909 579,512 0.45 0.39 0.42 0.11 0.15 0.13 16.65 28.83 22.74 2.53 6.71 4.62 16.12 20.73 18.43 0.13 0.15 0.14 0.48 2.36 1.42 1.87 0.18 1.03

1.66 0.27 1.34 1,510,343 1,203,658 1,367,902 0.18 0.13 0.16 0.32 0.36 0.34 19.60 21.61 21.49 6.39 11.78 9.69 18.37 24.52 21.77 0.33 0.36 0.35 0.47 1.92 1.68 5.01 0.22 3.65

211.94 (0.000)a

21.634 (0.103)

4.404 (0.000)a

21.195 (0.232)

26.623 (0.000)a

24.953 (0.000)a

22.393 (0.017)b

20.772 (0.441)

215.041 (0.000)a

5.425 (0.000)a

Notes: a/b statistically signicant at less than 1%/5% levels respectively, two-sided tests

board independence was operationalized by combining independent directors and non-independent non-executive directors, which were divided by the board size, the nding of which shows that board independence remained insignicant. Results with respect to CEO duality are mixed. In Models 1, 2 and 3 where CEO duality is dened as the CEO-cum-board chairman, the relation is found to be negative but it is not signicant. Thus, H2 is not supported. However, in Model 4, when CEO duality is dened as executive chairman, the inuence becomes negative, as predicted and signicant. Thus, H2 is supported. Model 3 tests also whether the effects of management ownership on nancial distressed status is curvilinear by including MOWN2 in Model 3. Results suggest that the relation of management interests with nancial distressed status is not linear. At the lower levels, interests by management lead to an alignment of interests. At the higher levels, the evidence

PAGE 588 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006

Table II Logistic regression analyses (N 504)

Variables Intercept YR1 YR2 BDIND NEDBOARD DUAL CHREXEC ACIND MOWN1 MOWN2 NEDOWN OUTBLK Model summary: Nagelkerke-R2 Chi-square 158.18* Classication performance Predicted signs ? ? ? Model 1 (Wald) 2.426 (24.867)a 0.160 (0.383) 0.127 (0.240) 0.832 (1.321) 20.445 (1.792)b 20.754 (4.589)b 20.063 (76.42)a 20.107 (50.229)a 20.046 (52.491)a 0.359 158.18a 73.6% Model 2 (Wald) 2.556 (24.607)a 0.172 (0.439) 0.133 (0.263) 0.420 (0.650) 20.417 (1.541) 20.702 (4.116)b 20.064 (83.31)a 20.114 (51.29)a 20.048 (54.94)a 0.358 157.04a 72.4% Model 3 (Wald) 3.052 (30.59)a 0.200 (0.586) 0.142 (0.298) 0.697 (0.896) 20.431 (1.641) 20.752 (4.450)b 20.117 (34.86)a 0.001 (9.534)a 20.118 (52.29)a 20.032 (10.546)a 0.377 167.5a 74.4% Model 4 (Wald) 2.180 (18.94)a 0.143 (0.306) 0.126 (0.234) 0.917 (1.597) 0.436 (3.631)b 20.697 (3.920)b 20.064 (78.59)a 20.101 (44.96)a 20.044 (48.43)a 0.363 160.04a 77.0%

Notes: NEDBOARD: percentage of non-executive directors on the board; CHREXEC: a dummy variable, 1 if executive chairman, 0 otherwise; astatistically signicant at less than 0.01 level, one-sided tests; b statistically signicant at less than 0.1 level, one-sided tests

Table III Further logistic regression analyses (N 504)

Variables Intercept YR1 YR2 BDIND BDSIZE CHREXEC ACIND MOWN INSDBLK NEDOWN NGOUTBLK GOVPCTG GOVLINK Model summary: Nagelkerke-R2 Chi-square Classication performance Predicted signs ? ? ? ? ? ? Model 1 (Wald) 2.129 (17.958)a 0.153 (0.343) 0.126 (0.233) 0.834 (1.283) 0.442 (3.692)# 20.613 (2.832)# 20.061 (69.88)a 20.099 (43.49)a 20.038 (29.47)a 20.063 (24.26)a 0.369 163.55a 75.6% Model 2 (Wald) 2.111 (17.81)a 0.139 (0.285) 0.124 (0.227) 0.856 (1.347) 0.408 (3.148)# 20.591 (2.633)# 2 20.062 (70.56)a 20.099 (43.69)a 20.038 (29.47)a 20.063 (24.16)a 0.372 164.63a 76.0% Model 3 (Wald) 1.402 (9.43)a 0.104 (0.172) 0.119 (0.224) 1.307 (3.428)# 0.471 (4.475)# 20.798 (5.524)* 2 20.055 (65.196)a 20.087 (37.096)a 20.033 (24.99)a 21.020 (3.960)b 0.311 134.06a 73.6% Model 4 (Wald) 5.416 (48.976)a 0.197 (0.504) 0.111 (0.160) 20.566 (0.483) 20.435 (37.948)a 0.345 (1.947)# 20.137 (0.124) 2 20.054 (51.583)a 20.084 (30.988)a 20.035 (22.26)a 20.053 (16.92)* 0.454 209.63a 76.0%

Notes: NGOUTBLK: percentage of shares held by outside blockholders not related to government; GOVPCTG: percentage of shares held by government; GOVLINK: a dummy variable, 1 if government holds 5% or more shares and 0 otherwise; astatistically signicant at less than 0.01 level, one-sided tests; bstatistically signicant at less than 0.1 level, one-sided tests

supports the management entrenchment theory. This is generally consistent with Morck et al. (1988) and Short and Keasy (1999). Findings in Table II, for all models, provide support for H3, H4 and H5. Table III presents results from additional analyses to test further the inuence of ownership and board size. In Model 1, outside blockholders are broken down into two: percentage of government-linked outside blockholdings and percentage of non-government related outside blockholdings. Government-linked entities are government-linked institutional investors (both the Federal and the State-linked funds and companies) and government-supervised funds. Findings of Model 1 indicate that H1 is not supported, while H2, H3, H4 and H5 are supported. Model 2 in Table III tests the association of inside blockholders on nancial distressed status. Results are similar to those found earlier. In Model 3 of Table III, the percentage of government-linked outside blockholders was treated

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 589

as a dummy variable. Results show that both non-government outside blockholders and government-linked variables are not signicant in determining the rm status. Finally, in Model 4, a variable board size is included. Jensen (1993) and Lipton and Lorsch (1992) argue that large board boards are not effective compared to smaller boards. Yermack (1996) provides empirical evidence supporting this contention. Nonetheless, having more directors on a board could enable the rm to utilize the expertise and services of the directors particularly when the additional directors are outsiders as argued by the resource dependency theory (Tricker, 1984, p. 171) and could serve as the window to the outside world and are better able to form environment link (Goodstein et al., 1994). Thus, larger board sizes should lead to lower probability of a rm to become distressed. Findings by Chaganti et al. (1985) show that non-failed rms have larger boards than failed rms. However, an oversized board size could lead to the problem of coordination (Forbes and Milliken, 1999), which potentially leads to the board becoming less involved in strategic decision making (Judge and Zeithaml, 1992). Thus, Jensen (1993) argues that the maximum size of a board is seven or eight. Based on the extant evidence, Hermalin and Weisbach (2003, p. 13) conclude that The data therefore appear to reveal a fairly clear picture: board size and rm value are negatively correlated. Nevertheless, neither too small a board nor too large a board may be effective. Rather increasing the size the board up to the optimum number (7-8 as argued by Jensen (1993)) should lead to effective monitoring. While increasing the size once it has reached the optimum size should result in the board becoming ineffective. The Malaysian boards were found to have about eight directors (Abdullah, 2001). Thus, it is predicted that there is a negative association between board size and the distressed status. Results in Model 4 of Table III are as predicted and consistent with Jensens (1993) argument and the ndings by Chaganti et al. (1985). Further, the board size in Malaysia in the present study is about seven, which is similar Mak and Lis (2001) ndings that found Singaporean board size being eight.

Conclusions
Findings of the present study do not support the contention that board independence is signicant in explaining a rms distressed status. This evidence contradicts that of Elloumi and Gueyie (2001) but consistent with the ndings by Chaganti et al. (1985). The passive roles of independent directors could be attributed to the nature of their appointments and their conict of roles (Vicknair et al., 1993; Perry, 1995; Bhagat and Black, 1997). An analysis was carried out to determine if the composition of the board had been changed during the period 1999-2001. The percentages of independent directors for both distressed and non-distressed sub-samples changed marginally during the period, suggesting some board restructuring in 2001, the year prior to the implementation of PN4 classication in 2002. Independent directors may not be aware of their responsibilities. Thus, requiring them to undergo training may help them to improve their monitoring skills. Future research, perhaps, as argued by Daily et al. (2003), could apply such theories as resource dependence and stewardship as well collecting process-oriented data that could offer alternative explanation of the boards roles. Evidence of the roles of CEO duality in determining the rms nancial distress is mixed. This evidence is consistent with previous studies in Malaysia (Abdullah, 2004; Abdullah and Mohd-Nasir, 2004) and in Canada (Elloumi and Gueyie, 2001). The insignicance of CEO duality could perhaps be due to the lack of consensus on the recommendation for the separation, as argued by Elloumi and Gueyie (2001). In fact, the existing corporate governance codes, e.g. the Cadbury Code, 1992 (Cadbury Committee, 1992); the Hampel Report (1998); the Malaysian Code on Corporate Governance (Finance Committee on Corporate Governance, 2001), do not prohibit the practice of combining the board chairman and CEO roles, provided that companies disclosed in the annual reports the reason for the departure. Furthermore, previous literature and evidence on the signicance of CEO duality are mixed (Berg and Smith, 1978; Chaganti et al., 1985; Daily and Dalton, 1994a) and some even have questions on the benets from the separation (Goodwin and Seow, 2000). Combining the top two roles enable urgent strategic decisions to be made faster especially during declining performance.

PAGE 590 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006

The ndings reveal the signicant associations of ownership structure with the distressed status, lending support for agency theory (Jensen and Meckling, 1976; Jensen, 1993). These ndings are also consistent with the ndings of Elloumi and Gueyie (2001) who found that interest by non-executive directors and outside blockolders are negatively associated with nancial distress. The evidence also conrms the curvilinear effects of management on interests on rms value found by Morck et al. (1988) and Short and Keasy (1999). This evidence reects the importance of the ownership pattern in corporate governance among Malaysian companies.

References
Abdullah, S.N. (2001), Characteristics of boards of directors and audit committees among Malaysian listed companies in period leading to 1997 nancial crisis, Akauntan Nasional, October, pp. 18-21. Abdullah, S.N. (2004), Board composition, CEO duality and performance among Malaysian listed companies, Corporate Governance: International Journal of Business in Society, Vol. 4 No. 4, pp. 47-61. Abdullah, S.N. and Mohd-Nasir, N. (2004), Accrual management and the roles of boards of directors and audit committees among Malaysian listed companies: evidence during the Asian nancial crisis, IIUM Journal of Management & Economics, Vol. 12 No. 1, pp. 49-80. Abu-Bakar, F. (2001), Corporate governance in nancially troubled companies, paper presented at Seminar on Corporate Governance: Issues and Challenges, Universiti Utara Malaysia, 10 June. Admati, A., Peiderer, P. and Zechner, J. (1994), Large shareholder activism, risk sharing, and nancial market equilibrium, Journal of Political Economy, Vol. 102 No. 6, pp. 1097-130. Altman, E.I. (1968), Financial ratios, discriminant analysis and the prediction of corporate bankruptcy, Journal of Finance, Vol. 23, September, pp. 589-609. Amihud, Y. and Lev, B. (1981), Risk reduction as managerial motive for conglomerate mergers, Bell Journal of Economics, Vol. 12, pp. 605-17. Argenti, J. (1986a), Predicting corporate failure, Accountancy, April, pp. 157-8. Argenti, J. (1986b), Spot danger signs before its too late, Accountancy, July, pp. 101-2. Aziz, A., Emanuel, D.C. and Lawson, G.H. (1988), Bankruptcy prediction: an investigation of cash ow based models, Journal of Management Studies, Vol. 25, pp. 419-37. Baldwin, J. and Glezen, G.W. (1992), Bankruptcy prediction using quarterly nancial statement data, Journal of Accounting, Auditing and Finance, Vol. 7, pp. 269-89. Baysinger, B. and Butler, H.N. (1985), Corporate governance and the board of directors: performance effects of change in board composition, Journal of Law, Economics and Organization, Vol. 1, pp. 101-24. Beatty, R.P. and Zajac, E.J. (1994), Managerial incentives, monitoring, and risk bearing: a study of executive compensation, ownership, and board structure in initial public offerings, Administrative Science Quarterly, Vol. 39, pp. 313-35. Berg, S.V. and Smith, S.K. (1978), CEO and board chairman: a quantitative study of dual vs unitary board leadership, Directors and Boards, Vol. 3, pp. 34-9. Bhagat, S. and Black, B. (1997), The uncertain relationship between board composition and rm performance, working paper, Columbia Law School, New York, NY. Burt, R.S. (1983), Corporate Prots and Cooptation, Academic Press, New York, NY. Cadbury Committee (1992), Report of the Committee on the Financial Aspect of Corporate Governance, Gee & Co., London. Cameron, K., Kim, M. and Whetten, D. (1997), Organizational effects of decline and turbulence, Administrative Science Quarterly, Vol. 32, pp. 222-40. Carcello, J.V. and Neal, T.L. (2000), Audit committee composition and auditor reporting, The Accounting Review, Vol. 75, pp. 453-68. Carcello, J.V. and Neal, T.L. (2003), Audit committee characteristics and auditor dismissals following new going-concern reports, The Accounting Review, Vol. 78, pp. 95-118.

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 591

Chaganti, R.S., Maharajan, V. and Sharma, S. (1985), Corporate board size, composition and corporate failures in retailing industry, Journal of Management Studies, Vol. 22, pp. 400-17. DAveni, R.A. (1990), Top managerial prestige and organizational bankruptcy, Organizational Science, Vol. 1, pp. 121-42. DAveni, R.A. and MacMillan, I. (1990), Crisis and the content of managerial communications: a study of the focus of attention of top managers in surviving and failing rms, Administrative Science Quarterly, Vol. 35, pp. 634-57. Daily, C.M. (1995), The relationship between board composition and leadership structure and bankruptcy reorganization outcomes, Journal of Management, Vol. 21, pp. 1041-56. Daily, C.M. (1996), Governance patterns in bankruptcy reorganizations, Strategic Management Journal, Vol. 17, pp. 355-75. Daily, C. and Dalton, D.R. (1994a), Corporate governance and the bankrupt rm: an empirical assessment, Strategic Management Journal, Vol. 15 No. 8, pp. 643-54. Daily, C.M. and Dalton, D.R. (1994b), Bankruptcy and corporate governance: the impact of board composition and structure, Academy of Management Journal, Vol. 37, pp. 1603-17. Daily, C.M., Dalton, D.R. and Cannella, A.A. Jr (2003), Corporate governance: decades of dialogue and data, Academy of Management Review, Vol. 28 No. 3, pp. 371-82. Dutton, J. and Duncan, R. (1987), The creation of momentum for change through the process of strategic issue diagnosis, Strategic Management Journal, Vol. 8 No. 3, pp. 279-95. Elloumi, F. and Gueyie, J. (2001), Financial distress and corporate governance: an empirical analysis, Corporate Governance: The International Journal of Business in Society, Vol. 1 No. 1, pp. 15-23. Fama, E.F. and Jensen, M.C. (1983), Separation of ownership and control, Journal of Law and Economics, Vol. 88 No. 2, pp. 288-307. Finance Committee on Corporate Governance (2001), Malaysian Code on Corporate Governance, Malayan Law Journal Sdn Bhd, Kuala Lumpur. Forbes, D.P. and Milliken, F.J. (1999), Cognition and corporate governance: understanding boards of directors as strategic decision-making groups, Academy of Management Review, Vol. 24, pp. 489-505. Gales, L.M. and Kesner, I.F. (1994), An analysis of board of director size and composition in bankrupt organizations, Journal of Business Research, Vol. 30 No. 3, pp. 271-92. Geneen, H. (1984), Why directors cant protect shareholders, Fortune, Vol. 17, pp. 28-32. Gilson, S.C. (1990), Bankruptcy, boards, banks, and blockholders, Journal of Financial Economics, Vol. 25, pp. 355-87. Goodstein, J., Gautam, K. and Boeker, W. (1994), The effects of board size and diversity on strategic change, Strategic Management Journal, Vol. 15, pp. 241-50. Goodwin, J. and Seow, J.L. (2000), Corporate governance in Singapore: perceptions of investors, directors and auditors, Accounting and Business Review, Vol. 7 No. 1, pp. 39-68. Hambrick, D.C. and DAveni, R.A. (1988), Large corporate failures as downward spirals, Administrative Science Quarterly, Vol. 33, pp. 1-23. Hambrick, D.C. and DAveni, R.A. (1992), Top team deterioration as part of the downward spiral of large corporate bankruptcies, Management Science, Vol. 38, pp. 1224-66. Hambrick, D.C. and Jackson, E.M. (2000), Outside directors with stake: the linchpin in improving governance, California Management Review, Vol. 42, pp. 108-27. Hampel Report (1998), Final Report of the Committee on Corporate Governance, Gee, London. Hermalin, B.E. and Weisbach, M.S. (1988), The determinants of board composition, RAND Journal of Economics, Vol. 19 No. 4, pp. 589-606. Hermalin, B.E. and Weisbach, M. (2003), Boards of directors as an endogenously determined institution: a survey of the economic literature, FRBNY Economic Review, April, pp. 1-13, available at: www.newyorkfed.org/research/epr/03v09n1/0304herm.pdf (accessed 29 January 2005).

PAGE 592 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006

Ho, S.M. and Wong, K.S. (2001), A study of the relationship between corporate governance structure and the extent of voluntary disclosure, Journal of International Accounting, Auditing & Taxation, Vol. 10, pp. 139-56. Jensen, M.C. (1993), The modern industrial revolution, exit, and the failure of internal control system, Journal of Finance, Vol. 48 No. 4, pp. 831-80. Jensen, M. and Meckling, W. (1976), Theory of the rm: managerial behavior, agency costs, and capital structure, Journal of Financial Economics, Vol. 3 No. 4, pp. 305-60. Judge, W. and Zeithaml, C. (1992), Institutional and strategic choice perspectives on board involvement in the strategic decision processes, Academy of Management Journal, Vol. 35, pp. 766-94. Kang, J.K. and Shivdasani, A. (1995), Firm performance, corporate governance, and top executive turnover in Japan, Journal of Financial Economics, Vol. 38 No. 1, pp. 29-59. Kesner, I.F. (1987), Directors characteristics and committee membership: an investigation of type, occupation, tenure and gender, Academy of Management Journal, Vol. 31, pp. 66-84. Kesner, I.F., Victor, B. and Lamont, B. (1986), Board composition and the commission of illegal acts: an investigation of Fortune 500 companies, Academy of Management Journal, Vol. 29, pp. 789-99. Kini, O., Kracaw, W. and Mian, S. (1995), Corporate takeovers, rm performance, and board composition, Journal of Corporate Finance: Contracting, Governance and Organization, Vol. 1 No. 3, pp. 383-412. Kosnik, R.D. (1987), Greenmail: a study of board performance in corporate governance, Administrative Science Quarterly, Vol. 32 No. 2, pp. 163-85. Levitt, A. (1998), The numbers game, The CPA Journal, December, pp. 14-19. Lipton, M. and Lorsch, J. (1992), The modest proposal for improved corporate governance, Business Lawyer, Vol. 48 No. 1, pp. 59-77. Lorsch, J.W. (1989), Pawns or Potentates? The Reality of Americas Corporate Boards, Harvard Business School Press, Boston, MA. Louden, J.K. (1982), The Director: A Professionals Guide to Effective Board Work, Amacom, New York, NY. McConnell, J.J. and Servaes, H. (1990), Additional evidence on equity ownership and corporate value, Journal of Financial Economics, Vol. 27, pp. 595-612. Mak, Y.T. and Li, Y. (2001), Determinants of corporate ownership and board structure: evidence from Singapore, Journal of Corporate Finance, Vol. 7, pp. 235-56. Mizruchi, M.S. (1983), Who control whom? An examination of the relation between management and boards of directors in large American corporations, Academy of Management Review, Vol. 8, pp. 426-35. Mohd-Nasir, N. and Abdulah, S.N. (2004), Voluntary disclosure and corporate governance among nancially distressed listed rms in Malaysia, Financial Reporting, Regulation and Governance, Vol. 1 No. 1, pp. 95-139, available at: www.cbs.curtin.edu.au/index.cfm?objectId=55489367D582-2975-B8105F3A1FB1979F. Morck, R., Shleifer, A. and Vishny, R. (1988), Management ownership and market valuation: an empirical analysis, Journal of Financial Economics, Vol. 20, pp. 293-316. Noe, T. (2002), Institutional activism and nancial market structure, Review of Financial Studies, Vol. 15, pp. 289-319. Oswald, S.L. and Jahera, J.S. (1991), The inuence of ownership on performance: an empirical study, Strategic Management Journal, Vol. 12 No. 4, pp. 321-6. Perry, J.P. (1995), The Cadbury Committee and corporate governance in UK, The CPA Journal, May, pp. 24-8. Pfeffer, J. and Salancik, G.R. (1978), The External Control of Organizations: A Resource Dependence Perspective, Harper & Row, New York, NY. Platt, H.D. and Platt, M.B. (2002), Predicting corporate nancial distress: reections on choice-based sample bias, Journal of Economics and Finance, Vol. 26 No. 2, pp. 184-99.

VOL. 6 NO. 5 2006 CORPORATE GOVERNANCE PAGE 593

Selznick, P. (1949), TVA and the Gross Roots: A Study in the Sociology of Formal Organization, Harper & Row, New York, NY. Shivdasani, A. and Yermack, D. (1999), CEO involvement in the selection of new board members: an empirical analysis, Journal of Finance, Vol. 54, pp. 1829-53. Shleifer, A. and Vishny, R.W. (1986), Large shareholders and corporate control, Journal of Political Economy, Vol. 94 No. 3, pp. 461-88. Shleifer, A. and Vishny, R.W. (1997), A survey of corporate governance, Journal of Finance, Vol. 52 No. 2, pp. 737-83. Short, H. and Keasy, K. (1999), Managerial ownership and the performance of rms: evidence from the UK, Journal of Corporate Finance, Vol. 5, pp. 79-101. Singh, J. (1986), Performance, slack, and risk taking in organization decision-making, Academy of Management Journal, Vol. 29, pp. 562-85. Staw, B.M., Sandelands, L. and Dutton, J. (1981), Threat-rigidity effects in organizational behavior: a multilevel analysis, Administrative Science Quarterly, Vol. 26, pp. 501-24. Tricker, R.I. (1984), Corporate Governance: Practices, Procedures and Powers in British Companies and Their Boards of Directors, Gower Publishing, London. US Congress (2002), The Sarbanes-Oxley Act of 2002: 107th Congress of the United States of America, HR 3763, Government Printing Ofce, Washington, DC. Vanhorne, J. (1971), Financial Management and Policy, Prentice-Hall, Englewood Cliffs, NJ. Vicknair, D., Hickman, K. and Carnes, K.C. (1993), A note on audit committee independence: evidence from NYSE on grey area directors, Accounting Horizons, Vol. 7 No. 1, pp. 53-7. Walsh, J.P. and Seward, J.K. (1990), On the efciency of internal and external corporate control mechanisms, Academy of Management Review, Vol. 15, pp. 421-58. Weisbach, M. (1988), Outside directors and CEO turnover, Journal of Financial Economics, Vol. 20 Nos 1/2, pp. 431-60. Whetten, D. (1987), Organizational growth and decline process, in Coleman, J. (Ed.), Annual Review of Sociology, Vol. 13, Annual Reviews, Palo Alto, CA, pp. 78-101. Wruck, K.H. (1990), Financial distress, reorganization, and organizational efciency, Journal of Financial Economics, Vol. 27, pp. 419-44. Yermack, D. (1996), Higher market valuation for companies with a small board of directors, Journal of Financial Economics, Vol. 40 No. 2, pp. 182-212.

About the author

Shamsul Nahar Abdullah is an Associate Professor in the Faculty of Accountancy, Universiti Utara Malaysia, Kedah, Malaysia. He can be contacted at: snahar@uum.edu.my

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com Or visit our web site for further details: www.emeraldinsight.com/reprints

PAGE 594 CORPORATE GOVERNANCE VOL. 6 NO. 5 2006