Corporate Governance and Contingency Theory: A Structural Equation Modeling Approach and Accounting Risk Implications PDF
Preview Corporate Governance and Contingency Theory: A Structural Equation Modeling Approach and Accounting Risk Implications
Contributions to Management Science Abdul Ghofar Sardar M.N. Islam Corporate Governance and Contingency Theory A Structural Equation Modeling Approach and Accounting Risk Implications Contributions to Management Science More information about this series at http://www.springer.com/series/1505 Abdul Ghofar (cid:129) Sardar M.N. Islam Corporate Governance and Contingency Theory A Structural Equation Modeling Approach and Accounting Risk Implications AbdulGhofar SardarM.N.Islam BrawijayaUniversity VISES,CollegeofBusiness Malang VictoriaUniversity Indonesia Melbourne Australia ISSN1431-1941 ISSN2197-716X(electronic) ISBN978-3-319-10995-4 ISBN978-3-319-10996-1(eBook) DOI10.1007/978-3-319-10996-1 SpringerChamHeidelbergNewYorkDordrechtLondon LibraryofCongressControlNumber:2014956505 ©SpringerInternationalPublishingSwitzerland2015 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpart of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation,broadcasting,reproductiononmicrofilmsorinanyotherphysicalway,andtransmissionor informationstorageandretrieval,electronicadaptation,computersoftware,orbysimilarordissimilar methodologynowknownorhereafterdeveloped.Exemptedfromthislegalreservationarebriefexcerpts inconnectionwithreviewsorscholarlyanalysisormaterialsuppliedspecificallyforthepurposeofbeing enteredandexecutedonacomputersystem,forexclusiveusebythepurchaserofthework.Duplication ofthispublicationorpartsthereofispermittedonlyundertheprovisionsoftheCopyrightLawofthe Publisher’s location, in its current version, and permission for use must always be obtained from Springer.PermissionsforusemaybeobtainedthroughRightsLinkattheCopyrightClearanceCenter. ViolationsareliabletoprosecutionundertherespectiveCopyrightLaw. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. While the advice and information in this book are believed to be true and accurate at the date of publication,neithertheauthorsnortheeditorsnorthepublishercanacceptanylegalresponsibilityfor anyerrorsoromissionsthatmaybemade.Thepublishermakesnowarranty,expressorimplied,with respecttothematerialcontainedherein. Printedonacid-freepaper SpringerispartofSpringerScience+BusinessMedia(www.springer.com) Preface Introduction There are many studies that focus on observing corporate governance and its effectiveness. However these studies have several major limitations, namely: (1)mostoftheresearchhaspaidlessattentiontoenvironmentalandorganizational factors that might influence firms in structuring their corporate governance and might have an impact on the effectiveness of corporate governance (Aguilera, Filatotchev, & Jackson, 2008); (2) the studies usually focus only on a single role or dimension of corporate governance effectiveness, that is, either on the perfor- mance role or earnings quality role; (3) the studies discuss the determinants and effectivenessofcorporategovernanceseparately;(4)theresearchhaslargelybeen undertaken in developed countries which have different control system and prob- lemscomparedtodevelopingcountries;and(5)methodologically,ingeneral,they userelativelylessvalidandreliablemeasuresinrepresentingthecorporategover- nanceconstruct(Larcker,Richardson,&Tuna,2007).Asaresult,researchonthe effectiveness of corporate governance has produced mixed results, thus limiting understanding of the effectiveness of corporate governance, as well as the deter- minantsofpoorlygovernedfirms. Objectives Drawingfromcontingencytheory,thegeneralresearchobjectiveofthisstudyisto analyse factors (business competition and strategy) which influence or determine corporate governance structure and the effectiveness of corporate governance (improving performance and earnings quality by minimizing the likelihood of earnings management) in an integrated theoretical and conceptual framework formalizedandmodelledbystructuralequationmodelling(SEM)methods. v vi Preface The specific objectives of this study are (1) to apply the developed theoretical andconceptualframeworkandthemodeltoIndonesiaasacasestudyforillustra- tions,operationalizationandinvestigationoftheargumentsdevelopedinthisstudy and(2)toanalysethecasestudyandmodelresultscomparativelywithotherstudies andcountriesformakinggeneralconclusionsandtheorydevelopment. Critical Literature Review The contingency theory of corporate governance has two main arguments, which are(1)businessenvironmentandstrategydeterminescorporategovernancestruc- ture;and(2)corporategovernancehastworoles,whichareimprovingperformance and ensuring the quality of earnings by minimizing the likelihood of earnings management. It is argued that in competitive industries, firms tend to have weaker corporate governance, as competition might reduce agency problems, while corporate gov- ernance mightimpose hightangibleandintangiblecosts. Prospectortype strategy firms,whicharecharacterizedasinnovative,aggressiveandhighgrowthfirms,are arguedtohavestronggovernanceinordertoassisttheminselectingandmanaging riskyprojects,aswellasmanagingdiversifiedandcomplexorganizations. With regard to the roles or objectives of corporate governance, the normative argument asserts that corporate governance should be able to achieve both roles (performance and earnings quality/financial control role) simultaneously. Never- theless, the normative argument has been challenged, as the financial control role might jeopardize managerial flexibility which leads to poor performance (Young, 2003). Hendry and Kiel (2004) argued that the balance between the financial control and strategic control role would depend on the environmental and organi- zational context in which a firm operates. Therefore, as corporate governance structureanditseffectivenessaredeterminedbyenvironmentalandorganizational factors, research should include the determinants and effectiveness of corporate governance in an integrated model to obtain a better understanding of corporate governancestructureanditseffectiveness. Methodology This study employs structural equation modelling (SEM), using Analysis of Moment Structures (AMOS)for data analysis, because it allows the evaluationof the reliability and validity of indicators used in representing a complex construct, suchascorporategovernanceandbusinessstrategy.Itisalsopossibletoexaminea series of dependence relationships among the measured variables and latent con- structs, aswellasbetweenseveralconstructssimultaneously, asdevelopedinthis Preface vii study. This study uses 66 Indonesian firms which were selected using purposive samplingmethodassamples,andathree-yearperiod(2008–2010)forobservations (198observations).TheIndonesianapplicationwasthecasestudyforillustrations forapplyingtheargumentsdevelopedinthisstudy.However,theresultsfromthe casestudyandmodelwereanalysedcomparativelywithotherstudiesandcountries formakinggeneralconclusionsandhypothesis/theorydevelopment. Results, Discussion, and Implications The findings suggest that business competition as an environmental factor and strategyasanorganizationalfactorinfluencecorporategovernancestructure.Mar- ket competition was found to be a substitute of corporate governance. Prospector strategy type firms were also found to have stronger governance. It can be con- cludedthatinstructuringtheircorporategovernance,firmsmightnotonlyconsider regulations, but also business environment and strategy. With regard to corporate governance effectiveness, this study found that corporate governance had a nega- tive relationship with earnings management, indicating that corporate governance was effective in improving earnings quality. That also showed that corporate governancecouldbeusedasariskmanagementmechanismespeciallyinmitigat- ing accounting risks. However, it failed to provide any strong evidence on the relationshipbetweencorporategovernanceandperformance.Thisfindingindicates that Indonesian corporate governance is dominated by an ethical-based approach, which highlights the financial control role of corporate governance. The findings provide general and comparative insights into the issues of corporate governance anditseffectivenessanddeterminantsrelevantforwidercontexts. ManythankstoProfessorPeterSheehanandAssociateProfessorErnChenLoo for their intellectually stimulating comments. We would also like to show our special thanks to Associate Professor Ern Chen Loo and Neelan Mahraj for their thoughtfulscrutinyandproofreadingofthewholewrittendocument. WewouldliketoexpressourheartfeltthankstoDr.RodTurnerwhoprovided valuablefeedbackonthemethodologysectionofthisbookparticularlyinregardto the Structural Equation Modelling (SEM). His many years of expertise and deep knowledgeaboutSEMhelpedestimationoftheSEMmodelinthebook. The authors also would like to thank the editorial team at Springer Verlag, especially Dr. Prashanth Mahagaonkar and Ms. Barbara Bethke, Editors at Springer, for their excellent help and outstanding professionalism in dealing with our book publication issues, tasks and processes. We are very happy for their supportandgratefultothem. Malang,Indonesia AbdulGhofar Melbourne,VIC,Australia SardarM.N.Islam ThiSisaFMBlankPage Acknowledgement Themodellingandanalysisworkinthisbookisbasedonthefollowingpublications oftheauthors: 1. Ghofar,A.,&Islam,S.M.N.(2013).Determinantsandeffectivenessofcorpo- rate governance. 10th Asian Business Research Conference, October 6–7th, 2014,Bangkok,Thailand. ix
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