Term Paper on "Boards of Directors, Corporate Governance and Market"

Term Paper 40 pages (13662 words) Sources: 1+

[EXCERPT] . . . .

Boards of Directors, Corporate Governance and Market Value of the Firm. Do Shareholder profit from Board Reforms driven by Regulators? Evidence from Switzerland

The concept of firm

The agency problem

Definition of corporate governance

Mechanisms of corporate governance

Literture review - Part II

Board of directors - introduction

Models of boards

One-tier vs. two-tier board model

The case of Switzerland

CEO duality

Outsider directors / board independence

Board size

Board committees

Interlocking directorates

Multiple board appointments

Frequency of board meeting

Board diversity

Regulatory development

The case of Switzerland

Board index

Board impact on firm valuation

Performance measure

Long-term equity return

Current board structure

Potential research problem

Ethical issues of the proposed research

Expected research outcomes

Abstract

The proposed research focuses on a fundamental element of the corporate governance process, the board of directors. In particular, the research addresses the question whether boards of directors as the "apex" of the organization increase firm value.

This paper outlines the research proposal which seeks to explore whether good board governance leads to higher common stock returns for Swiss companies. The research will involve the construction of a survey-based "Board Index" using provisions based on a Code of Best Practice portfolios consisting of companies that conform with the code and others that do not conform to best practice are constructed and then stock-returns are compared.

Introduction

The proposed research focuses on a fundamental element of the corporate governance process, the board of directors. As the literature review will show, the arena of corporate governance is very large, encompassing countless issues that academics have struggled with for years. Corporate governance addresses the agency problems that are induced by the separation of ownership and control and are prevalent in the contemporary corporation worldwide (Berle & Means, 1932; Jensen and Meckling; 1976; Gompers et al., 2003). According to Fama (1980) agency problems are the necessary evils of an "efficient form of economic organization" called firms where the various resource owners are pooled together in order to produce goods or services demanded by customers at the lowest cost. Therefore, boards of directors must be convinced of the importance of grappling with and managing corporate governance for their long-term survival and growth.

The board of directors is an important institution in the governance of modern corporations. Fama and Jensen (1983) view the board as "the apex of internal decision control systems of organizations." The fundamental role of the board is to control managerial behaviour and ensure that managers act in the interest of the shareholders. Being the "apex" of the organization the board is responsible for the firm specific corporate governance framework.

The board of directors has received considerable attention from academic researchers (Dalton et al., 1998; Zahra & Pearce 1989). In particular, studies on board composition and board leadership structure and its relationship to firm performance have accounted for the bulk of research (Zahra and Pearce, 1989, Johnson, Dailly and Ellstrand, 1996; Forbes and Miliken, 1999; Huse 2000, Hermalin and Weisbach, 2003). Empirical findings of the board's impact on firm performance have been inconclusive (Bhagat and Black, 1999; Dalton et al., 1998).

Nevertheless, corporate boards are the focus of many attempts to improve corporate governance. Regulators and shareholder advocates in the U.S. have called for smaller boards with greater outside representation among U.S. corporations (The Business Roundtable 1997). This movement toward specific board guidelines, typically calling for greater independence, independence outside representation, and requirements that boards have audit committees that consist only of independent outside directors, is a characteristic of the Codes of Best Practice issued in many countries (Denis & McConell, 2003). In Switzerland, for example, the "Directive on Information Relating to Corporate Governance" and the "Swiss Code of Best Practice" have become a listing requirement on the Swiss Stock Exchange as of July 1, 2002. Yet despite the extensive research, there is no clear empirical evidence that shareholders benefit from these regulations.

The proposed research addresses a number of important issues relating to corporate governance, board of directors, firm value and the relationship between these in Switzerland. Foremost, among these research questions is: Do well-governed boards of directors, measured in regulator's terms, increase long-term equity returns?

A test can be carried out in order to evaluate the hypothesized relationship between board governance quality and firm valuation; a board-index may then be constructed based on a survey of all listed companies on the Swiss Stock Exchange (SWX) (Beiner, p. 3). Based on this index, portfolios can be built, consisting of companies with well-governed or poorly governed boards. In addition, following the portfolios, a comparison of their long-term equity returns may be done (Beiner, p. 3).

It was only until recently that the development of a governance index has become popular in the literature research. For example, Drobetz, Schillhofer and Zimmermann (2003) in Germany, Zimmermann et al. (2004) in Switzerland and Gompers, Ishii and Metrick (2003) in the U.S., construct a corporate governance index and analyze the relationship between corporate governance and long-term equity return. The authors report that well-governed companies have proven to have higher equity returns, are valued higher and have accounting statements that show a better operating performance in the end.

Although the proposed research has similarities to the work of Drobetz, Schillhofer and Zimmermann (2003) and Gompers et al. (2003), the research design differs in an important aspect: the different focus on corporate governance. In this study the centre of attention is the board of directors and not overall corporate governance. The logic behind this approach is that the board of directors is the "apex" of the organization and, therefore, determines the company's overall corporate governance framework. A poor governed board would, ceteris paribus, most likely create a poor governance framework. The proposed study is, in certain ways, an update of the Zimmermann et al. (2004) research which surveyed Switzerland for the year of 2001 and 2002.

The major contributions of the proposed research to the literature are:

This study measures the impact of well- and poorly governed boards on their long-term equity return:

This study uses a data set from an institutional environment different than most available empirical evidence;

This study describes the characteristic of boards of directors in Switzerland that are relevant for regulators;

This study shows to what extent boards comply with best practice.

The remainder of this paper is organized as follows. Section 3, 4, 5 and 6 summarize the main body of the relevant literature, namely corporate governance, board of directors, the current research based on governance indices and the regulatory development. Section 7 draws a conclusion and presents the objectives of the proposed research. In section 8, the research design is presented. Finally, section 9 presents the expected research outcomes.

Literature Review - Part I

The literature review is divided into three parts. The first part discusses the theory of the firm, the agency problem and corporate governance. The second part introduces the board of director because this research focuses on this fundamental element of corporate governance. The third part summarizes the recent research about the impact of individual countries' corporate governance rules or corporate practice on individual firm's value and performance.

This first section of the review addresses the theory of the firm. Popular theories and their attempt to describe the firm, as well as its boundaries, are reviewed here. This section provides the necessary background to understand what exactly is being governed. It is appropriate that a study on corporate governance begins by looking at the firm itself.

The next section addresses the agency problem which has a great relevance for corporate governance. The section reviews the agency problem from various points-of-view and explains why corporate governance is so important. This discussion leads then into the detailed discussion of corporate governance and its legal and economic forms. Of particular interest for this research project is the outline of the economic forms of corporate governance. These forms are the building blocks available to the board of director to create firm value through good governance. Thus, this discussion of corporate governance is essential to understand the proposed research.

The concept of the firm

What is the "animal" we are trying to govern? Numerous theories have been developed over the years, some building on each other, and other in conflict. The theories of the firm to be identified in this review include, Coase's ground breaking rational for the existence of the firm, Demsetz's presentation of the pure economic theory of the firm, and Williamsons' idea of the firm as a governance structure explained via transaction cost economics. A brief review of mechanism design, the classical model of the entrepreneur, and the property rights theory of the firm are also considered. Finally, the firm as a nexus of contracts as explained by Jensen and Meckling will conclude the discussion.

As discussed above, there are several theories of the firm and its boundaries. One of the more popular and most cited accounts comes from Ronald Coase (1937). Coase argued "that a firm is not an organization but an organism, automatically regulated… READ MORE

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