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Managing Knowledge, Technology and Development in the Era of Information Revolution

Corporate governance and performance: the case of


Jordanian stock companies
Moh'd Mahmoud Ajlouni
Yarmouk University,
Jordan
Abstract
This study aims at examining the effects of ownership structure, mix and
foreign ownership on firm performance. Using Amman Stock Exchange (ASE)
listed companies during the period 19921994, the analysis is performed by
employing three ratios as proxies of firm performance, Market Value to Book
Value (MVBV), Return on Equity (ROE) and Return on Assets (ROA).
Empirical results show little evidence on the role for the large and institutional
shareholders in monitoring and controlling the behaviour of the management.
Similarly, there were no evidences on the effect of government ownership and
firm performance. Finally, ASE does not value ownership mix. The weak and
insignificant results might be due to the parametric model specifications used.
It might be useful to suggest the use of non-parametric techniques, such as
Data Envelopment Analysis (DEA).

Introduction

Corporate Governance (CG) has developed often in response to corporate failure, crisis,
fraud and abuse and incompetence. The Asian crisis of the 1997 and the failure of large
corporations, such as Enron of USA and Vivindi of France, were due to poor
governance. These led many governments and international organisations, such as the
World Bank (WB), International Monetary Funds (IMF) and Bank of International
Settlement (BIS), to promote CG mechanisms.
Private sector investment, inter alias, has been identified as a key for economic
growth and sustainable development. Restructuring State-Owned Enterprises (SOEs) has
been considered as a cornerstone of economic reform and cultural changes. Jordan has
been witnessing rapid economic growth and a changing investment environment, due to
a series of privatisation initiatives and a record high of Arab direct and indirect
investments. Jordan is making every effort to make it attractive to investors. Since the
mid-1990s, Jordan is fostering a transparent investment climate. Stock companies are
regulated by the Companies Act, which is supervised by the Controller of Companies, as
well as by the Securities Act, which is supervised by the Securities Exchange
Commission (SEC), Amman Stock Exchange (ASE) and the Securities Depository
Center (SDC).

The concept of CG

Governance, as a political term, is


Copyright 2007 World Association for Sustainable Development (WASD)

M.M. Ajlouni
an analytical concept that specifies the forms of power and authority, patterns
of relationship and rights and obligations might typify a particular approach to
governing [it] has become a shorthand term used to describe a particular set
of changes (Newman, 2001, p.11).

It designates a set of deceptive significant shifts in the way governments seek to govern
(Pierre and Peters, 2000). It refers to the enhancement of ways of coordinating economic
activity that go beyond the limitations of both hierarchy and markets (Rhodes, 1997).
CG, as an economic term, is a managerial discipline that specifies a system by which
firms are directed and governed. It emerged as a result of growing separation of
ownership and control in the modern corporations of the 1930s. The transformation of
mom and dad businesses into large corporations has created a higher demand for
large capital that could no longer be financed individually (Jensen, 1993). This new
structure of ownership has created a new paradigm (Jensen and Meckling, 1976). Under
the agency theory, such relationship has become as a principal agent relationship,
whereby the shareholders are the principals and the managers are the agents (Fama and
Jensen, 1983).

CG mechanisms

CG mechanisms are economic and legal foundations that can be forced through the
political process (Shleifer and Vishny, 1997). Agency theory is concerned with the
asymmetric information in the principal-agent relationship on one hand; and with
the contract design (compensation) that motivates the agent to act in the principals
interests, on the other hand. CG can be devised by internal initiatives or through external
pressures, explained as follows.
1

Internal governance mechanisms: agency theory introduces the notion of


internal governance mechanisms as agency controls in order to minimise agency
costs and the subsequent damage to principals wealth. Internal mechanisms
centre on contracts and incentives and focus on ownership and organisational
structures. The main agency controls are executive compensation schemes
(Hallock and Murphy, 1999a,b) and governance structures such as the Board of
Directors and the separation of roles between Chief Executive Officers (CEOs)
and Chairpersons of companies (Machold and Vasudevan, 2004). The agency
costs are real as any other cost. However, firms directors face a number of
pressures of varying intensity that help align their interests with those of
shareholders. These include the threat of legal action of violation of fiduciary
duties (Starks, 1987), the threat of removal by dissatisfied shareholders (proxy
fight), and the discipline of the non-executive directors.
External governance mechanisms: in addition to the internal mechanisms, firms
directors face a number of external pressures. These include the threat of hostile
takeover (Manne, 1965), and the competition from other potential directors is
supplied by the managerial labour market (Jensen and Meckling, 1976).
In addition, the capital markets constrain the agency cost. On one hand, when
incompetent management depreciates the market value of the firm, shareholders
have the option of selling their firm. Also, rival firms may induce shareholders
to sell their firm in a process of takeover. In either case, agency costs will be
eliminated completely (Jensen and Meckling, 1976). On the other hand, the
capital market provides directors with an opportunity to invest their inside
information in insider trading. Ajlouni (2004) shows that this will have a

Corporate governance and performance

positive effect on directors effort, which is in line with the shareholders


interest and thus reducing the agency costs at no cost. CG policy is better being
internally driven. That is so because, on one hand, principals obviously prefer
internal controls (Walsh and Seward, 1990) because they have lesser impact on
their own wealth than the external regulations (Smallman, 2004). On the other
hand, agents naturally would not prefer external pressures that carry the threat
of firing and penalties.

CG models

The differences in the conceptualisation of corporations as well as their governance have


led to the emergence of different CG models. The two main models are:
1 The Anglo-Saxon view: the shareholder model a liberal and individualist
approach to property and CG (Letza and Sun, 2004), this model is mostly
adopted in the UK, USA, Canada and Australia. Frederick von Hayek and
Milton Friedman are the major proponents of this model, which focus solely on
protecting and maximising shareholders wealth. Other stakeholders should be
served by contracts and government regulation, and should not be a function of
CG. To sum up, this model is characterised by three distinct features:
a the Board of Directors represents the shareholders only
b very concerned shareholders
c the variability of the shareholders whose investment horizon is short term.
2 The GermanJapanese view: the stakeholder model this model is mostly
adopted in the continental Europe and Japan. It views the corporation as a social
institution with a distinct public role and responsibilities (Kay and Silberston,
1995). Thus, the firm is not a private organisation and shareholders are not the
only constituency with the rights to be heard. Employees, suppliers, government
and the whole community are all represented in the Board of Directors.
Financial institutions are dominant shareholdings (Machold and Vasudevan,
2004). To sum up, this model is characterised by three distinct features:
a the Board of Directors represents employees, suppliers, large customers and
other stakeholders, in addition to the shareholders
b unconcerned shareholders
c the stability of and longer-term shareholders investment in the firm.
Other models of CG include the stewardship model (Davis et al., 1997), the finance
model (Manne, 1965), the myopic model (Keasey et al., 1997), the social entity model
(Gamble and Kelly, 2001), the pluralistic model (Kelly and Parkinson, 1998), the
trusteeship model (Kay and Silberston, 1995) and the most recent Community Interest
Company (CIC) model (Low and Cowton, 2004).

CG in emerging markets: the case of Jordan

The 1990s Asian financial crisis demonstrated what risks would arise when financial
institutions are subject to political influence, particularly, when corporate management is
weak and lacks accountability, transparency and control (Wade, 2000). As a result of the
crisis, CG in the emerging markets has come under scrutiny. However, the literature on
CG models in emerging markets is limited (Shleifer and Vishny, 1997), while that in

M.M. Ajlouni

Jordan is dearth. However, the emerging markets tend to favour the Anglo-Saxon
shareholder model, while not ignoring the stakeholder model.
Jordan is a small, but vital country, located in the heart of the Arab World. It has a
population of 5.5 million. The majority of the population is Muslim, and Islamic customs
govern the general way of life. The population is highly educated. Jordan has one of the
most open political systems in the region. The basic infrastructure is well developed.
Skill forces, communications, tax incentives and other facilities required for business are
exceptionally good. The government has made efforts to create a liberal and attractive
business environment. Capital market in Jordan is among the oldest ones in the region.
Established in 1978, it consists of three separate, but related entities. These are Jordan
Securities Commission (JSC), ASE and the Securities Depository Centre (SDC). There
are more than 175 companies listed, with more than US$10 billion market value,
representing more than 100% of the GDP and an average of one billion shares and
70 million bonds traded annually.
Jordanian corporations are regulated by the Companies Act of 1997 and Securities
Act of 2002. Both laws require interval, transparency and timely disclosures of financial
and non-financial information. The Controller of Companies and JSC are playing a vital
role in supervising companies and performing an agency control on the management of
companies. Both authorities have the power to issue warnings, fines, suspend and de-list
companies. There is no recent evidence of CG scandal in Jordan and disclosures can be
assessed as relatively good. That is so because Jordanian corporations are directed by
good CG and disclosure principles. Ownership rights are secured and distinctly
organised. Companies listed in the First Market of ASE are required to issue financial
statement information quarterly, while those on the Second Market semiannually.
However, the Board of Directors is appointed, not elected. The government, through its
investment arm, the Investment Unit of the Social Security Corporation (SSC),
holds a substantial stake in most of ASE large corporations. Although financial
disclosure is somehow good, access to and dissemination of non-financial information
is relatively weak.

The data

Using data for the listed companies in ASE, we examine the effects of state ownership,
legal person ownership and individual private ownership on firms performance.
The data set includes all ASE listed companies during the period 19921994. There were
119 firms listed in 1992 and 148 firms listed in 1994. Table 1 shows the summary
statistics of financial information and profitability ratios of Jordanian listed companies,
exhibited according to the four main sectors during 1992 and 1994 while Table 2 shows
the ownership structure of Jordanian listed companies, exhibited by type and nationality
of the investors, and sectoral category during 1992 and 1994.
The ownership of Jordanian government and its agencies in ASE listed companies
decreased from 13% of the total ownership in 1992 to 12% in 1994. However, its direct
ownership increased from 1% to 6% while its agencies ownership decreased from 12% to
6% during the period of the study. In fact, the reason behind that is the conversion of
public enterprises into public shareholding companies, of which the government owns
100% of the companies, but planning to sell its shares to strategic local and/or foreign
investors.

Corporate governance and performance

The analysis

The analysis of the data is performed by using three financial ratios as proxies of firm
performance. These are Market Value to Book Value (MVBV), Return on Equity (ROE)
and Return on Assets (ROA). Ownership structure is represented by two measures:
concentration ratio, which is the percentage of shares held by top 10 shareholders (CR10)
and Herfindahl index of ownership concentration, which is the sum of squared
percentage of shares held by top 10 shareholders (HERF). ASE companies guide,
issued every other year, reports CR10 for all listed companies, while HERF is calculated
in this paper.
Let P represent performance measures, P = MVBV, ROA and ROE, and OC
represent ownership concentration ratios, OC = CR10 and HERF. If ownership structure
does not matter, there would be no correlation between P and OC. Thus, the first null
hypothesis would be:
Hypothesis I: There is no relationship between ownership structure and firms
performance. That is the irrelevance of ownership concentration.
Control variables used in this paper that might affect the performance include Net
Income (NI), Debt Ratio (DR) and the industrial sector of the firms as a dummy variable.
Firms listed in ASE are classified into four major sectors. These are banks (DUMb),
insurance (DUMi), service (DUMs) and manufacturing (DUMm) sectors. This
hypothesis is tested by the following equation:
4

P = i DUM i + 1 NI + 2 DR + 3 CR10 + 4 HERF +

(1)

i =1

where all Greek letters are coefficients, is the error term with a covariance matrix
COV(j, k) = 0 for j k, and VARj VARk. That is, the variance of j differs across
firms. DUM(ij) = 1 if firm j is in industry i and zero otherwise.
Equation (1) tests the null hypothesis for 1992 and 1994 data. Estimation results are
reported in Table 3. Regardless of the performance measure used (MVBV, ROA or
ROE), the null hypothesis cannot be rejected at 5% level of significance or less, for both
1992 and 1994 data. That is, ownership concentration is irrelevant to firms performance.
However, the table reports that the concentration ratio (CR10) in 1994 is significant at
6% level, and the model (F = 1.93) at 9%. However, none of the control variables is
significant. On the other hand, 1992 model of ROA was the best in explaining 63.6% of
the relationship between performance and concentration, control and dummy variables,
and significant at less than 1%. However, only one independent variable is significant,
that is, NI.
Theoretically, well-functioning markets, such as the product market, the managerial
labour market and the merger market, are the keys in establishing CG and, thus,
ownership is irrelevant. Fama (1980) claims that ownership is an irrelevant concept since
the firm is a set of contracts. Jensen (1993) demonstrates the role of the market for
corporate control. Thus, the second null hypothesis would be:
Hypothesis II: There is no relationship between ownership mix and firm's
performance. That is the irrelevance of ownership mix.

6
Table 1

M.M. Ajlouni
Summary statistics of financial information and profitability ratios of all Jordanian
listed companies, exhibited by sector, during 1992 and 1994

Corporate governance and performance


Table 1

Summary statistics of financial information and profitability ratios of all Jordanian


listed companies, exhibited by sector, during 1992 and 1994 (continued)

8
Table 2

M.M. Ajlouni
Ownership structure of all Jordanian listed companies, exhibited by type and
nationality of the investors, during 1992 and 1994

Corporate governance and performance


Table 2

Ownership structure of all Jordanian listed companies, exhibited by type and


nationality of the investors, during 1992 and 1994 (continued)

10

M.M. Ajlouni

Let P represent performance measures, P = MVBV, ROA and ROE, and OM is the
number of shares owned by the government divided by the total number of shares
outstanding. OM represents ownership mix ratios, FG1 = Fraction of equity owned by
government agencies and FG2 = Fraction of equity owned by government itself. If
ownership structure does not matter, there would be no correlation between P and OM.
The following equation tests this hypothesis:
4

i =1

j =1

P = i DUM i + 1 NI + 2 DR + B j FG j +

(2)

where all Greek letters are coefficients, is the error term with a covariance matrix
COV(j, k) = 0 for j k and VARj VARk. That is, the variance of j differs across
firms. DUM(ij) = 1 if firm j is in industry i and zero otherwise.
Equation (2) tests the null hypothesis for 1992 and 1994 data. Estimation results are
reported in Table 4. The null hypothesis is rejected at 6% level of significance for 1992
data. That is, ownership structure, represented by the percentage of governmental
agencies to the total ownership, is relevant to firms performance, when performance is
measured by MVBV, but not with ROA or ROE. The debt Ratio (DR) and the dummy
variable of the service sector are significant at 5% or less. Similar to results of Table 3.
Table 4 reports that 1992 model of ROA is the best in explaining 62% of the estimation
between performance and ownership structure, control and dummy variables, and
significant at less than 1%, with only one independent variable significant, that is, NI.
Since ownership structure and mix are irrelevant, and based on the theory of the firm
and the role of markets in corporate control, one might argue that foreign ownership is
irrelevant too. Thus, the third null hypothesis would be:
Hypothesis III: There is no relationship between foreign ownership and firms
performance. That is the irrelevance of foreign ownership.
Let P represent performance measures, P = MVBV, ROA and ROE, and FO is the
number of shares owned by Arab and foreign investors divided by the total number of
shares outstanding. FO represents foreign ownership ratios, FO1 = Fraction of equity
owned by Arab individual investors, FO2 = Fraction of equity owned by Arab
companies, FO3 = Fraction of equity owned by foreign individual investors,
FO4 = Fraction of equity owned by foreign companies, FO5 = Fraction of equity owned
by non-Jordanian governments and FO6 = Fraction of equity owned by other type of
non-Jordanian shareholders. If foreign ownership does not matter, there would be no
correlation between P and FO.
This hypothesis is tested by the following equation:
P=

i =1

j =1

i DUM i + 1 NI + 2 DR + B j FO j +

(3)

where all Greek letters are coefficients, is the error term with a covariance matrix
COV(j, k) = 0 for j k and VARj VARk. That is, the variance of j differs across
firms. DUM(ij) = 1 if firm j is in industry i and zero otherwise.

Corporate governance and performance


Table 3

Estimation results of Hypothesis I irrelevance of ownership concentration


to firms performance

11

12
Table 4

M.M. Ajlouni
Estimation results of Hypothesis II irrelevance of ownership mix to firms
performance

Corporate governance and performance

13

Equation (3) tests the null hypothesis for 1992 and 1994 data. Estimation results are
reported in Table 5. The null hypothesis cannot be rejected at even 10% level of
significance for 1992 and 1994 data. That is, ownership mix, represented by the
percentage of non-Jordanian to the total ownership, is irrelevant to firms performance,
when performance is measured by MVBV, ROA or ROE. Once again, Table 5
reports similar results to Tables 3 and 4 in that, the 1992 model of ROA is the best in
explaining 59% of the estimation between performance and ownership mix, control
and dummy variables, and significant at less than 1%, with only NI significant
control variable.

Conclusion

Empirical results produced in this paper show little evidence on the importance of
relative ownership concentration on firms performance. That is, there was no role for the
large and institutional shareholders in monitoring and controlling the behaviour of the
management. In fact, the correlation between performance and the concentration ratios
was very weak and insignificant. The correlation between MVBV and CR10, for
example, was 11.4% (23.4%), between ROA and CR10 was 9.1% (12.6%), and between
ROE and CR10 was 19.8% (4.5%) in 1992 (1994). One explanation for this conclusion
would be the fact that ownership of Jordanian firms is not highly concentrated.
The percentage of owners who own 10% or more (CR10) was only 29% (27%) in 1992
(1994). However, institutional investors owned about 42% of Jordanian firms in 1992
and 1994 (see Table 2).
Similarly, there were no evidences on the effect of government ownership and firm
performance. That is, ownership structure of Jordanian firm is irrelevant to their
performance. Government ownership has no positive or negative impact on performance.
The correlation between performance measures (MVBV, ROA and ROE) and ownership
structure (government ownership) was 1.6%, 4.2% and 2.0% (0.5%, 8.9% and 1%)
in 1992 (1994), respectively. Thus, reducing or increasing government shares in listed
companies is irrelevant to firms performance. In other words, the market does not value
ownership structure of Jordanian firm. That is because publicly traded companies do not
suffer from free-ride problem that most companies do in the emerging markets.
This might be used as an indication of transparent and efficient market for listed
companies in Jordan.
Finally, ownership mix is irrelevant to Jordanian firms performance. It seems
that ASE does not value ownership mix, and that share prices do not reflect this
variable. The correlation between performance measures (MVBV) and ownership mix
(all Arab and all foreign investors) was 9.2%, and 4.5% (10.5% and 3.6%) in 1992
(1994), respectively. The weak and insignificant results of this paper might be due to the
model specifications used, including but not limited to the model being a parametric
one. It might be useful to suggest the use of non-parametric model to investigate the
relationship between firms performance and ownership concentration, structure and
mix. The Data Envelopment Analysis (DEA) might be the alternative one to be used
in this context.

14
Table 5

M.M. Ajlouni
Estimation results of Hypothesis III irrelevance of foreign ownership
to firms performance

Corporate governance and performance

15

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