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The Impact of Government Linked Directors

on Firm Performance: Evidence from


Oman
Mohamed A. Elhabiba* Siti Zaleha Abdul Rasidband Rohaida Basiruddinc,
Hamed Sayyard
International Business School (IBS), Universiti Teknologi Malaysia, 54100 KL,
Selangor, Malaysia
*a

mohamedateia2@gmail.com, bszaleha@ibs.utm.my,
d

rohaida@ibs.utm.my,

H_sayyar_63@yahoo.com

ABSTRACT
The presence of government-linked board members can be an effective corporate governance
mechanism and a valuable resource for companies. The presence of such board members
based on resource dependence theory is expected to enhance firm performance. This paper
investigates the impact of government-linked board members in Oman on firm performance
using Return on Assets and Tobins Q as proxy for firm performance. The findings of the
study revealed that having a government linked board member such as a royal family
member, a cabinet minister or a deputy minister on the board of a listed company have a
positive but insignificant with firm performance as measured by both ROA and Tobins Q.
However, statistical analysis show that the presence of a government representative as a
board member has a positive impact on firm performance, as indicated by the positive
coefficient for ROA and TOBINQ. An important implication of this result is that the
presence of a government representative as a board member has a positive impact on firm
performance, indicating that government employees board members is a valuable resource to
the firm. This result is in line with the presumption of the resource dependence
theory, that board members can act as a link between firms and access to valuable
resource.(Hillman et al., 2009). Regulators such as Oman Capital Market Authority
can use the study findings to issue recommendations to restructure boards in a way
that some firms do not gain preferential treatment because of connection to
government and political lobbyist.

Keywords: Corporate Governance; Performance; Oman; Frequency of


Board Meetings; Directors Busyness

1.0 Introduction
The existence of government-linked board members can be effective corporate
governance mechanism that is very crucial to firm success. The presence of such board
members based on resource dependence theory (Haniffa and Hudaib, 2006; Hillman,
2005; Hillman et al., 2009) is expected to enhance firm performance. Corporate
governance has come to the forefront of knowledge as a distinct and expanding field of
study during the last three decades (Elhabib et al., 2014; Parker and Hoque, 2014). The
extant literature revealed that there is no agreement among researchers and organizations
on a single definition for Corporate Governance, as definitions differ based on the
perspectives and the varying outlooks and exposure of researchers (Armstrong and
Sweeney, 2002; Hussain and Mallin, 2002; Mallin, 2002; Mallin, 2011; Solomon, 2007).
Some definitions have been criticized as being too narrow, while others have been
criticized as being too broad (Agle, 2008; Ntim, 2009). A definition is classified as too
broad if it focuses on all stakeholders protection without defining who these
stakeholders are (Gillan and Starks, 2003; Gillan, 2006; Letza et al., 2004; Sternberg,
1997a, 1997b), while it is classified as too narrow if it focuses on shareholders interest
maximization and disregards or ignores other stakeholders interests.
The most widely used definition for corporate governance is the Cadbury Report
definition, where it defines corporate governance as how companies are managed and
controlled (Cadbury et al., 1992; Tricker, 2015). This definition highlights the need for
good management and good control without getting into the dilemma of being pro
maximization of shareholders interests or pro protection of stakeholders. In 1999 the
Organization OECD offered a more comprehensive definition that defines Corporate
Governance as a set of processes, customs, policies, laws, and institutions affecting the
way a corporation is directed, administered or controlled (Clarke, 2007) . In 2001 the
Organization for Economic Cooperation and Development (OECD) defined corporate
governance as a system governing the relationship between executive management and
shareholders (Nestor, 2001). Both OECD definitions focus on managing and controlling
the relationship between corporate managers and equity owners in order to mitigate the
negative impact of the agency conflict.
According to Velnampy (2013), corporate governance is concerned with ways in which
all stakeholders implement mechanisms to protect their interests. Velnampys definition
is considered too broad because of the infinite number of stakeholders involved.
According to Rezaee (2008), corporate governance can be defined as a process through
which shareholders induce management to act in their interest, providing a degree of
confidence that is necessary for capital markets to function effectively. Rezaee (2008)
definition heavily draws from agency theory and emphasizes the need to induce
management, probably to arrive at some goal congruence where executive
managements interests are aligned to the interests of shareholders. In light of the above,
it can be concluded that there is significant disagreement among researchers and
institutions, concerning the definition of corporate governance (Armstrong and
Sweeney, 2002; Sayyar et al., 2014; Solomon, 2007). Following a resource dependence

theory, government linked-directors may provide a firm with access to external


resources that can enhance firm performance (Haniffa and Hudaib, 2006; Hillman et al.,
2009)
This paper examines the impact of government-linked board members on firm
performance for listed non-financial companies in Oman. The Sultanate of Oman offers
a good context where the nexus between governments linked directors, and firm
performance can be investigated.
2.0 Literature Review
According resource dependence theory, the presence of a government-linked board
member such as royal family members, cabinet ministers, undersecretary ministers, or
government employees (Hillman, 2005) is expected to have a positive impact on these
firms performance. Based on the assumptions such board members can help firms to
have access to sources of low cost financing (Mian and Khwaja, 2004) in addition to
having insider information about government projects and strategic plans concerning the
industry in which the firm operates (Salancik and Pfeffer, 1978). Goldman et al. (2008)
in a study he conducted for a sample of US companies that support the winning party
and those supporting the losing party, he found that firms those support the winning part
have a higher chance of winning government procurement contracts. Based on the
prepositions of both resource dependence and information asymmetry and managerial
signalling theories the presence of such members is expected to have a positive
relationship with firm performance (Hillman, 2005).
Boubakri et al. (2012) in a study that investigates the relationship between political
connections of 234 public listed firms and firm performance for the years 1989 to 2003,
they find that political connection increase both firm performance and leverage. This
results is supported by resource dependence theory that politically connected board
members will give a firm access to government resources (Salancik and Pfeffer, 1978).
The difference of this study and the study at hand is that this study does not measure the
impact of board members it measure political of CEO, vice presidents, secretaries and
big major shareholders, it measures of board members who are linked to government.
In an empirical study conducted in 2005 using data for 300 listed firms for the year
2000, Hillman (2005) found that there is a positive relationship between the expolitician as board members and firm performance as measured by Tobins Q, he also
found that the relationship is more stronger in regulated industries. This findings confirm
the positive impact of government-linked directors. However, the short time horizon of
only one year and the limited number of observations of only 300 observations may cast
doubt on the validity of the result have it been replicated using a longer time span or
more observations.
Goldman et al. (2009) using a sample for board members of S&P 500 who are
connected to political parties, they found that the announcement of a politically
connected board member affect share price, confirming the assumption of signalling

theory that the quality of board members may provide good signal to the market. The
shortcomings of this study is the limited time span only one year and the limited
financial performance proxies by using only stock price as proxy for firm performance.
To sum up, it is obvious government connected firms have better firm performance
(Hilman, 2005), easy access to finance (Mian and Khwaja, 2004), more probability of
winning procurement contracts (Golman et al.,2008) and higher stock market price
(Niessen and Ruenzi, 2010). However, there is paucity of rigorous research that
examines that impact of the presence of incumbent cabinet ministers, undersecretaries,
and royal family members on firm performance. The above studies concentrated on
overall political connectedness of the firm, its executive, CEO and secretaries. Unlike
previous studies, the current study focuses on the influence board members who are
currently holding a cabinet minister, an under-secretary, or a royal family member on
firm performance. To the researchers knowledge, this is the first study to address the
impact of government-linked board members.
3.0 Hypothesis Development
Following a resource dependence theory, the presence of a government-linked board
member such as royal family members, cabinet ministers, undersecretary ministers, or
government employees is expected to have a positive impact on these firms financial
performance. Based on the assumptions such board members can help firms to have
access to sources of low cost financing in addition to having insider information about
government projects and strategic plans concerning the industry in which the firm
operates. Some studies that investigated the impact of ex-politician found that there is
positive impact on linkage with government and firm performance (Boubakri et al.,
2012). Based on the propositions of both resource dependence and information
asymmetry and managerial signalling theories the presence of such members is
expected to have a positive relationship with firm performance, leading to hypothesis
thirteen and hypothesis fourteen;
H1: Having a board member who is a royal family member, a minster, or an
undersecretary on the board is positively associated with firm performance
H2: The existence a government employee on the board positively impact firm
performance

4.0 Research Methodology


4.1 Model Set Up
FPit=0+1GMTLD1sit + 2 GMTLD2si+3 TOTAST+4LNLEV+ ..+eit

Where:
FPit
0
GMTLD1
GMTLD2
TOTAST
LNLEV
e it

= Firm performance as measured by ROA, and Tobins Q


= Constant
= The presence of a government representative as board member
= The presence of a royal family member, a cabinet minister or
undersecretary minister in the board
= Firm size as measured by Total assets (TOTAST)
= Leverage as measured by the natural logarithm for
ratio of DEBT/TOTAL ASSETS
= Error term

4.2 Control Variables


Total Assets [TOTAST]
Due to the cost of monitoring, which only big firm can afford, public scrutiny, business
complexity, and agency conflict firm size is expected to be positively related to better
corporate governance and firm performance (Beiner et al., 2006; Jensen, 1986). Haniffa
and Hudaib (2006) found that ROA to have a positive correlation with firm
performance, while, other researchers such as Agrawal and Knoeber (1996) and Durnev
and Kim (2005) found a negative relationship with firm value as measured by Tobins
Q. Following previous researchers Owusu (2012) firm size is proxied for by total asset
[TOTAST] which is measured by the book value of total assets at year end. For the
purpose of this research, it is hypothesized that firm size as measured by the book value
of total assets is expected to have a negative relationship with Tobins Q and a positive
relationship with other firm performance metrics.
Leverage [LEV]
Leverage, is defined as the ratio of long-term debt to total assets. Leverage is expected to
have a negative correlation to firm performance and lower risk of financial distress
(Gonzlez, 2013; Opler and Titman, 1994). Weill (2003) finds that the association
between leverage and firm performance, differs from country to another, due to
differences in the legal system and access to bank finance, this finding explains the
difference in results obtained by researchers. Similar to researchers such as (Agarwal
and Elston, 2001; Campello, 2006; Rahaman, 2011) This study uses leverage as a
control variable is measured as the natural log for the ratio of the value of outstanding
long-term debt to total assets.

4.3 Variables
4.3.1 Government-linked Director [GMTLD]
This construct is proxied for using two variables. The first variable is GMTLD1 similar
to Boubakri et al. (2012) this variable is defined and is measured by, the presence of a
cabinet minister, an under-secretary, or a royal family member in the board at the end of
each year. If there is at least one board member is from any of the above categories 1 is
assigned otherwise 0 will be assigned.
The second variable is GMTLD2 similar to Lester et al. (2008) and Hillman (2005) this
variable is defined as the existence of a government employee on the board of a
company. For the purpose of this study this variable is measured by, the presence of a
current government employee as a representative in the board at the end the year. If
there is at least one a 1 is assigned otherwise 0 will be assigned.

4.3.2 Firm Performance Measures


4.3.2.1 Return on Assets [ROA]
Following (Arouri et al., 2014; Core et al., 2006; Gompers et al., 2003; Haniffa and
Hudaib, 2006; Sami et al., 2011) Return on Assets is defined as net profit from
operations after tax, divided by the book value of total assets. This ratio shows the
capability of the firms assets in making profits, it measures return for each dollar
invested in total assets, it also indicates the efficacy of firms assets in growing
shareholders wealth, the productivity of firms assets and how efficient the executive
management in utilizing these assets. Unlike ROE, ROA is not affected by changes in
capital structure, at higher level of debts ROE become distorted and therefore, may not
represent management efficient utilization of assets(San and Heng, 2011). ROA is very
popular ratio that most researchers use for studying the relationship between corporate
governance and firm performance e.g.(Chaghadari, 2011; Giroud and Mueller, 2010;
Heenetigala, 2011; Joe Duke and Kankpang, 2011; Khatab et al., 2011; Ntim, 2009;
Uddin et al., 2014; Vafeas and Theodorou, 1998; Velnampy, 2013; Zeitun, 2014).
4.3.2.2 Tobins Q [TOBINQ]
Following previous researchers such (Gompers et al., 2003; Heenetigala, 2011; Klapper
and Love, 2004). Tobins Q is defined as market capitalization plus the book value
total assets minus shareholders funds divided by the book value of total assets. Tobins
Q is a very popular ratio by researchers in the area of corporate governance-firm
performance nexus(Al-Saidi and Al-Shammari, 2014; Black, Love, et al., 2006;
Chhaochharia and Grinstein, 2007; Dharmapala and Khanna, 2008; Drobetz et al., 2014;
Goldman et al., 2006, 2009; Klein et al., 2005; Lei and Deng, 2014; Rashid and Islam,
2008; Yaser and Denise, 2012). This ratio estimates the market value of firms using a
hybrid of both market and accounting data. A higher Tobin Q ratio indicates that the
firm is valued high by market and lower ratio. As a rule of thumb a ratio lower than one
signals that the company is under-valued.

4.4 Data Collection


Data has been collected from the following three main sources (i) DATASTREAM (ii)
firms annual report, and (iii) corporate governance reports. Every listed company is
required to file a report every year containing important disclosures about firm
compliance to Oman corporate governance code (2002). It is worth mentioning that most
data relating to firm performance and control variables are extracted from
DATASTREAM, only, missing years are collected from firm annual reports. However,
corporate governance data is collected from corporate governance reports and annual
reports.
4.4.1 Sample and Years of the Study
The sample for study consists of all the companies listed in Muscat Securities Market
(MSM) for a period of ten years from 2003 to 2012. The first year (2003) is the first year
for the enforcement of the code of corporate governance, starting with 2003 enables
tracking the impact of the gradual adoption of the code on firm performance. Moreover,
extending the research period until 2012 provides enough observations for a thorough
statistical analysis. Banks, finance and insurance companies are excluded because they
are subject to additional regulations by the Central Bank of Oman (CBO) that are more
stringent, where certain requirements for cash holdings and financial reporting affect are
imposed. These additional requirements may affect comparability of those companies
financial statements with other non-financial corporations(Adams and Mehran, 2012; De
Haan and Vlahu, 2012). Muscat Securities Market (MSM) has about 118 firms, when
the financial sector companies are excluded (34 firms), eighty four non- financial firms
will be left. Additionally, four firms with incomplete data are excluded reducing the
firms under study to eighty firms, which represents 95% of non-financial firms. Table 1
shows the distribution of the sample to the main sectors.
Table 1: Summary and Distribution of Firms under Study

Sector

Number
of Listed
Firms

Excluded
Firms

Net Firms

Total
FirmYear

Financial Firms

34

34

0%

Food and Beverages

18

18

180

100%

Industrial

30

27

270

90%

Services

36

35

350

97%

118

38

80

800

68%

Total
Final number of firms as
percentage of total nonfinancial firms

95%

5.0 Data Analysis


Data analysis is performed using descriptive statistics, correlation matrix, and OLS
multivariate regression using panel data for ten years study period from 2003 to 2012. In
addition to, other tests for sensitivity and robustness as necessary. For descriptive
statistics, the mean, the median, the standard deviation, minimum, maximum, skeweness
and kurtosis will be calculated for hypothesis variable, control variables, and dependent
variables. The purpose of descriptive statistics is to provide inferences about the data,
regarding, data distribution, and normality. Meanwhile, correlation matrix helps in
identifying the variables those may give rise to exact collinearity causing bias to OLS
regression results. In addition, OLS multivariate regression and other econometric tests
are used to ascertain the relationship between explanatory variables and the dependent
variable (performance metrics) and to corroborate OLS findings.
5.1 OLS Multivariate Regression
To measure the impact of the number of government-linked directors on firm
performance [FP]OLS multivariate regression test will be used following prior studies
(Black, Jang, et al., 2006; Owusu, 2012; Padgett and Shabbir, 2005; Velnampy, 2013;
Vishwakarma, 2015) that have used OLS to examine the relationship between corporate
governance and firm performance.
5.2 Descriptive Statistics
As shown in Table 2 row 1 the mean indicates that on average listed companies in Oman
have average asset sizes of RO 33 million (78 million US dollars). In addition, the very
high standard deviation of RO73 millions indicate that some companies have very low
total assets of around RO 0.6 million (1.5 million USD). Row 2 of Table 2 show that the
average debt ratio is 51% and the maximum is more than 300% and the minimum is zero
indicating that some firms are highly leverage while others do not have any leverage at
all. Rows 4, 5, and 6, reveal that non-financial companies listed in Muscat securities
market during the period 2003 to 2012 ; enjoy an average ROA of 5%, and a good
market value with a Tobin Q of 1.35.
Table 2: Descriptive statistics
Row
1
2
3
4
5
6
7

VARIABLE

TOTAST (millions)
LEV
LNLEV
ROA
TOBINQ
GMTLD1
GMTLD2

Obs. Mean

800
800
800
800
800
800
800

32976
51%
-0.888
5%
1.348
0.400
0.196

St. Dev.

72910.25
34%
0.706
11%
0.735
0.490
0.397

Min

Max

605
3%
-3.51
-48%
-0.07
0
0

729437
308%
1.12493
55%
7.8
1
1

5.3 Correlation Matrix


The pairwise correlation matrix as shown in table four revealed that there is a positive
relationship between GMTLD1, GMTLD2 and measures of firm performance. It also
revealed that has a weak positive relationship with Tobins Q. As expected Table 3
shows that total assets have a positive relationship with firm performance. Furthermore,
it reveals that leverage has a negative relationship with firm profitability while having a
positive relationship with firm value as measured by Tobins Q. A high correlation
between dependent variables is expected and correlation between independent variables
and dependent variables is desirable. Whereas, correlation among independent variables
may cause a problem of multicollinearity (Hair et al., 2006; Hair Jr et al., 2013) which
appear not to exist based on this correlation matrix which indicates the absence of
perfect multicollinearity.
Table 3: Pair-wise Correlation Matrix
VARIABLE
A GMTLD1
B GMTLD2
C TOTAST
D LNLEV
E ROA
G TOBINQ

A
1
0.1683
0.2552
-0.122
0.1323
0.0703

1
0.174
-0.212
0.169
0.1

1
0.0292
0.1862
0.1417

1
-0.327
0.137

0.13

5.4 Results
5.4.1 Multivariate result for Accounting-based FP proxy (ROA)
Row 2 of Table 4 exhibits that the presence government linked members who are either
royal family members, cabinet ministers or undersecretaries has an insignificant impact
of firm performance as measured by ROA. This result does not support the study
hypothesis (H1) that having a board member who is a royal family member, a cabinet
minister, or an undersecretary on the board is positively associated with firm
performance. However, the presence of a government employee as a board member is
found to have a positive and statistically significant relationship with firm performance
as measured by ROA. As can be seen from row3 of Table 4 the result is statistically
significant at P< 10%.

Table 4: Regression Results for ROA


Row

Variable

Coefficient (t-statistics)
-0.0071992
1
INTERCEPT
(-1.13)***
0.0086255
2
GMTLD1
(1.13)
0.0179993
3
GMTLD2
(1.91)*
0.000000262
4
TOTAST
(5.08)***
-0.0486668
5
LNLEV
(-9.3)***
6
Adj. R2
15%
*** are significant at p<0.01, ** are significant at p<0.05 and *at p<0.10.

5.4.2 Multivariate Regression Results for Market-based FP Proxy (Tobins Q)


As shown in row 2 Table 5 the result is insignificant for Tobins Q indicating that the
presence government linked members who are royal family members, cabinet ministers
or undersecretaries does not have impact on firm value. However, the impact of having a
government employee as a board member is found to have a statistically significant and
positive impact on firm value as measured by Tobins Q, which support the study
hypothesis (H2) that the presence of government employees as board members enhances
firm value.
Table 5: Multivariate Regression Results for Tobins Q
Row

Variable

Coefficient (t-statistics)
1.39629
1
INTERCEPT
(31.04)***
0.0667778
2
GMTLD1
(1.23)
0.200045
3
GMTLD2
(2.99)***
0.00000108
4
TOTAST
(2.95)***
0.1684238
5
LNLEV
(4.54)***
6
Adj. R2
5%
*** are significant at p<0.01, ** are significant at p<0.05 and *at p<0.10.

6.0 Discussion of Findings


The finding that having a government linked board member such as a royal family
member, a cabinet minister or an undersecretary on the board have a positive but
insignificant relationship with firm performance as measured by both ROA and Tobins
Q . Prior literature revealed there is a linkage between politically linked firms and firm
performance (Goldman et al., 2006, 2008, 2009; Hillman, 2005). Similarly, Boubakri et
al. (2012) find that political connection increase both firm performance and leverage.
As expected, OLS multivariate regression results show that, the presence of a
government representative as a board member has a positive impact on firm
performance, as indicated by the positive coefficient for ROA and TOBINQ. From a
resource dependence perspective (Haniffa and Hudaib, 2006; Salancik and Pfeffer,
1978), such board members are expected to help firm to secure cheap sources of low
cost financing in addition to having insider information about government projects and
strategic plans concerning the industry in which the firm operates (Haniffa and Hudaib,
2006; Hillman et al., 2009; Mian and Khwaja, 2004). Several prior studies have linked
government ownership with positive firm performance (e.g.(Aljifri and Moustafa, 2007)
(Arouri et al., 2011; Hasan and Al Mutairi, 2011; Uddin et al., 2014; Zeitun, 2014).
Based on the prepositions of both resource dependence and information asymmetry and
managerial signalling theories the presence of such members is expected to have a
positive relationship with firm performance (Hillman, 2005; Morris, 1987). This result is
in line with resource dependence and managerial signalling and support the second study
hypothesis (H2).
6.0 CONCLUSION
This study examined the relationship between government-linked directors and firm
performance in Oman using data for a census of nonfinancial firms for the years (2003
to 2012).
The statistical analysis shows that government-linked board members are considered a
valuable resource for companies, as the presence of such board members, based on
resource dependence theory, is expected to enhance firm performance.
The findings of the study also revealed that having a government-linked board member
such as a royal family member, a cabinet minister or a deputy minister on the board of a
listed company have a positive but insignificant with firm performance as measured by
both ROA and Tobins Q. However, statistical analysis show that the presence of a
government representative as a board member has a positive impact on firm
performance, as indicated by the positive coefficient for ROA and TOBINQ. Based on
the researchers knowledge this is the first study to examine the impact of governmentlinked directors who are currently holding a government office on firm performance.
This study has several important implications. The first implication is that the presence

of a government representative as a board member has a positive impact on firm


performance, indicating that government employees board members is a valuable
resource to the firm. This result is in line with the presumption of the resource
dependence theory, that board members can act as a link between firms and access to
valuable resource.(Hillman et al., 2009). The second implication is that regulators such
as Oman Capital Market Authority can use the study findings to issue recommendations
to restructure boards in a way that some firms do not gain preferential treatment because
of connection to government an political lobbyist.
This study has several limitations; the first is that the study is based on data for the
Sultanate of Oman. This limitation may have an impact on the generalizability to
countries with different business, developmental and regulatory environments. The
second limitation is that this study uses two proxies for firm performance that covers
only two aspects of firm performance. This may limit generalizability of the findings to
other aspects of firm performances such as firm short-term liquidity. The third limitation
is that the study uses data for non-financial firms only, which also limit the
generalizability of the study to financial firms and non-listed companies.
This study provides a number of research recommendations for future research. Firstly,
future research can replicate the study in other countries to assess the impact in a
different context. Secondly, researchers can use both listed and non-listed firms instead
of using only listed non-financial firms. Thirdly, researchers can also use other financial
proxies to see the impact of government-linked board members on those aspects such as
firm short-term liquidity and firm probability of corporate failure.

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