1.1 arnund the world have established corporate governance code

1.1 Background of the study

The end of 20th century foresaw great transformation in the
field of corporate governance. The change can be largely attributed to collapse
of big corporations such as Enron and Worldcom. closer to home, the financial
crisis experienced by the Asian Countries brought down many large as well as
small companies Coincidentally, the world economy, which was experiencing a
period of steady growth denoted by the bull market, takes a turn to slide down
to a bear market. The catastrophe of these events can be seen in the form of
thousands being made jobless and investors losing confidence in corporate
reporting as well as in corporate management as investors shoulder the losses
which cumulatively amounts to millions of dollars.

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 The above scenario
saw the resurgence of corporate governance which over the years has taken a
back seat due to thriving economy. Questions were raised as to whether the
board of directors and the management of the company are indeed strategically
managing the company and acting in the best interest of the shareholders as
well as stakeholders. In response to this, renulators arnund the world have established
corporate governance code to provide some guidelines to companies on how they
can enhance corporate governance with their organization.

1.2 Problem Statement

 The Securities
Commission in 1995 began work on a phased programme to move from merit based
regulation to disclosure based regulation with the aim to regulate the
Malaysian capital Market as well as to enhance and strengthen corporate
governance. This is aligned with the signalling theory which purports the fact
on the existence of information asymmetry between corporation and investors.
This is further reflected by the maxim that better disclosure and transparency
would lead to higher level of corporate performance (Black et al. 2003,
Botosan, 1997, Brouenen et al., 2001). However, the maxim remains debatable as
to whether the relationship between disclosure of corporate governance
practices and corporate performance do indeed moves in the same positive
direction. In light of this, this study seeks to examine extent of corporate
governance disclosure and the relationship between these variables corporate
governance practice (as indicated by corporate governance disclosure) and
financial performance.

1.3 Purpose of and significance of study

The insight into the relationship between disclosure of
corporate governance practices and financial performance will be beneficial in
promoting voluntary disclosure among corporations. Corporations whose main
objective is to maximize wealth would resort to disclose pertinent information
on their own accord if they could see that their actions results in positive
impact on their bottom line. Indirectly, this would create a more efficient
capital markets, as investors would have more confidence due to reduction in
information asymmetry as the result of high quality of corporate reporting.

1.4 Research Questions

 This study intends to
answer the following research questions

 1. What is the extent
of corporate govemance disclosure in the annual report of public listed
companies in Malaysia ?

2. Would companies with more corporate governance disclosure
as indicated by higher corporate governance score exhibits higher level of firm

3. would companies with more corporate governance disclosure
as indicated by higher corporate governance score exhibits higher level of
return on equity?

1.5 Research Methodology

 Based on the research
questions outlined above, this study uses a corporate governance index to
measure the corporate governance level of the sample of companies selected. The
index consist of attributes which measure corporate governance practise of
companies based on disclosure made in the annual report. Each company would be
assigned score according to their disclosure level. The scores (both in raw and
weighted form) are analysed using descriptive analysis to determine the extent
of corporate governance disclosures among the selected companies. Subsequently,
the scores are correlated and regressed against the firm value (as measured by
Tobin’s Q) and return on equity. This is to examine the association  and the strength of the relationship between
corporate governance and financial performance.

1.6 Scope of the study

The sample companies for this study are drawn from the top
100 companies traded in Bursa Malaysia Berhad according to their market
capitalisation or 23 December 2003. The rationale for this lies on the fact
that these companies forms a majority of volume of shares traded in the stock
exchange and hence they are expected to practice a high level of corporate
governance The 2003 annual reports of these companies were used to extract
information regarding their corporate governance practice. The year was chosen
as this is the 2003 latest annual report available for all the companies in the
sample and furthermore, it is assumed that the companies would have fully
adjusted to the revamped listing requirement implemented by Bursa Malaysia
Berhad in regard to corporate governance disclosure which became effective on
1st January 2001.

1.7 Limitation of the study

 The study is shadowed
by two major limitations. First, the usage of corporate governance index which
is open to individual biasedness and subjective assessment. Secondly, the
financial performance indicator used in the study may not highlight the
holistic financial health of the company.

1.8 Organization of the Study

 The study is divided
into five chapters.

Chapter 1- The chapter begins with a brief introduction on
importance and resurgence of corporate governance practice as a main discussion
issue in the corporate world and the value of good corporate governance
practise. In line with this, it then states the problem statement of the
research, purpose and significance of the study, research questions, the
methodology applied, the scope of the study, the limitation of the study and
finally it ends with the organization of the study

Chapter 2- Generally, this chapter covers earlier studies
and researches conducted in the field of corporate governance and financial
performance.It begins with the development of corporate governance initiatives
in Malaysia and the current status of the initiatives in terms of legal
requirements. It also discusses the issue of mandatory vs. voluntary disclosure
of corporate governance. Based on this, it was argued that if companies could
see that the disclosures leads to financial returns, then more could be done to
promote good corporate governance practices. The chapter then highlights
previous studies examining the link between corporate governance and financial

The studies are analysed in two parts. The first part covers
studies pertaining to the use of corporate governance index while the second
part covers studies examining specific corporate governance attributes.

Chapter 3-The chapter covers research methodology applied in
the study. It explains the corporate governance index used and the financial
performance indicators used. It also highlights the sample selection, data
collection procedure, hypotheses development and the statistical analysis

Chapter 4- The findings of the research and its’ analysis is
covered in this chapter.

Chapter 5- The chapter gives the summary of the study. It
also discusses the mplication of the study, its limitation and future research
that can be executed based on the findings of this research.



 2.1 Introduction

 This chapter highlights
the events and initiatives made in developing corporate governance in Malaysia.
It focuses on disclosures of corporate governance practices and discusses the
importance of voluntary disclosures as a mean to promote good corporate
governance practice. It is envisaged that companies would opt for voluntary
disclosure if good corporate governance practices realizes in higher financial
performance In light of this, studies examining the link between corporate
governance and financial performance are reviewed

2.2 Development of Corporate Governance in Malaysia

 The history of
corporate governance in Malaysia can be traced to the formation of Federation
of Public Listed Companies (FPLC) in April 1987 and the subsequent issuance of
Code of Ethics for Public Listed Companies in 1989. Nevertheless, it was the
Asian Financial crisis in 1997 which intensified initiatives in Corporate
Governance (Selvarajoo, 2003). One of the initiatives taken was the
establishment of The High Level Finance Committee in 1998 who build the
foundation of Corporate governance in Malaysia by establishing the Malaysian
Code on Corporate Governance Code (MCCG) in 1999

Bursa Malaysia Berhad  
(formerly known as Kuala Lumpur stock Exchange) also joins in the effort
of enhancing corporate governance in Malaysia by revamping its’ Listing
Requirements. Chapter 15 of the Revamped Listing Requirement addresses issues
on Corporate Governance and one of the paramount requirements has been spelt
out as below:

A listed issuer must ensure that its board of directors
makes the following statements in relation to its compliance with the Malaysian
Code on Corporate Governance in its annual report

(a) a narrative statement of how the listed issuer has
applied the principles set out in Part 1 of the Malaysian Code on Corporate
Governance to their particular circumstances, and

(b) a statement on the extent of compliance with the Best
Practices in Corporate Governance set out in Part 2 of the Malaysian Code on
Corporate Governance which statement shall specifically identify and give
reasons for any areas of non- compliance with Part 2 and the alternatives to
the Best Practices adopted by the listed issuer, ifany”

 The above mentioned
requirements was aimed for companies to be more transparent and accountable in
their actions in order to gain investors confidence. It is hope that this would
reduce the effects of agency theory and signalling theory and pave way for a
more efficient capital markets. Indirectly, it is also envisaged that these
efforts would boost the country’s economy growth as well as encourage inflow of
foreign direct investment In other words, good corporate governance is a key to
establish a robust and competitive corporat sector, which serves as a source
for sustainable economic growth (OECD 2001)

2.3 Mandatory vs. voluntary corporate Governance Disclosure

 Although the
regulators in Malaysia have created a commendable framework for Corporate
Governance, Malaysian corporations still have not achieved a satisfactory level
of corporate governance practice. This is evident from a joint survey conducted
by the investment bank Credit Lyonnais Securities Asia (CLSA and Asian
Corporate Governance Association in 2003 in which the country was ranked number
one (score of 9 out of 10) in terms of rules and regulation but only managed to
obtain an average score of 5.5 out of 10 for overall corporate governance
practice. In fact, many of the rules in the codes are only recommendations and
there is much scepticism that best-practise recommendation and/or
principle-based approaches are effective substitutes for more rule-based
approaches, such as the United States Sarbanes-Oxiey Act (Pension Investment
Research Consultant, 1998). Hence, this raises the question on whether
corporate governance disclosure Should be made  mandatory instead of voluntary

Nevertheless, it should be noted that Corporate Governance
at its core. is about interaction of human beings-the relationships in a
boardroom, or the ability of a non-executive to stand up to a dominant chief executive.
Thus, making corporate governance disclosure mandatory may hamper the spirit or
the very objective of Corporate Governance whereby companies disclose not with
the aim to strengthen Corporate Governance but more as compliance effort
(Minority Shareholders Watchdog Group, 2005)

There have been evidences suggesting that companies who
opted for voluntary disclosure deemed to have gained more benefit compared to
those who disclosed in adherence to mandatory requirement. In light of the
above argument, one could arrive at an assumption that in order to promote
voluntary disclosure of corporate governance practice, companies should be made
aware of the benefits they could attain especially in terms of higher corporate
performance. Although it has been accepted as a rule of thumb that better
corporate governance practices leads to higher corporate performance, empirical
researches have shown contradicting results. Consequently, a clear link between
corporate governance and financial performance could not be established.

 2.4 Corporate
Governance and Investors

Nevertheless, more research efforts should be channelled in
this area as results from most studies concur that investors are prepared to
pay premium for companies that are perceived to have good corporate governance
practices (Khoo, 2003). This is further supported by the McKinsey and Co
Investor opinion Study 2000 which found that 80% of the survey respondents are
prepared to pay more for the shares of well-governed companies than those of
poorly governed companies. In another survey carried out by the firm in 2002,
it was found that 15% of European institutional investors consider corporate
governance as more important than a firm’s financial issue. Additionally, the
survey also highlighted that 22% of European institutional investors are
willing to pay an average premium of 19% for a well governed company. Likewise,
in Malaysia, a similar conclusion was reached through the KLSE-
PricewaterhouseCoopers Corporate Governance Survey 2002 whereby it was found
that the institutional investors are willing to pay a premium of at least 10%
for share price of a well governed company (KLSE, 2003).

2.5 Corporate Governance and Financial Performance

The above section highlights the value of good corporate
governance from the perspective of investors and the need to have more
empirical research in establishing a sound link between good corporate
governance practices and corporate performance. In light of this, various
researchers have embarked upon the journey in a mission of finding the link
between corporate governance and financial performance The key findings of some
of these researches are discussed below.

The most comprehensive work on finding the link between
corporate governance and financial performance were carried out by Patterson
(2003) who reviewed numerous literatures before concluding that it is indeed
impossible to produce a conclusive evidence of such link due to the fact that
each research has defined corporate governance practices and measured financial
performance differently. Khoo (2003) further stated that differences in
measurement of performances, theoretical perspectives applied and the
contextual nature of the individual firms have hindered the ability to
establish the relationship between corporate governance and financial

The researches can be divided into two broad categories. one
of group researches attempts to examine the link of a range of corporate
governance practices on financial performance by constructing a governance index.
In most cases, the data for construction of the governance index are obtained
from independent govemance rating agency that specialises in analysis of
corporate governance practices over wide range of criteria. The other group of
researchers identifies the link by using selected corporate governance
practices or attributes.

2.5.1 Corporate Governance Index and Financial Performance

One of the notable researches in the first group is the
study conducted by Bauer et al. (2003) who utilized data obtained from Deminor
Corporate Governance Ratings for companies included In the FTSE Eurotop 300.
Using these data they build a portfolio consisting of well-governed and poorly
governed companies and compare the companies’ performance in terms of long term
equity returns, firm value, net profit margin and retum on equity. They found
that corporate governance standards have positive relationship with long term
equity and fim value. Surprisingly, their research found that corporate
governance standards have negative relationship with net profit margin and
return on equity. A possible explanation for this would be that the companies
with good governance rating may be more prudent in their accounting practices
and thus reports a conservative profit figure.

Their research was actually a reflection of an earlier
research carried out in United States by Gompers et al. 2003) who analysed
corporate governance practice on the same financial performance variables used
by Bauer et. al. (2003). Similar to Bauer et al. (2003), Gompers et al. arrived
at the same conclusion in which a positive correlation was found between
corporate govermance and long term equity and firm value. However, their
findings did not concur with findings of Bauer et. al. (2003) in respect to the
relationship between net profit margin and return on equity as it showed a
negative association. Gompers et al. (2003) research also highlighted that
firms with stronger shareholder rights had higher fim value, higher profits,
and higher sales growth, lower capital expenditures and made fewer corporate

 Brown and Caylor
(2004) found that firms with weaker corporate governance performed poorly, less
profitable, riskier and has lower dividend payout and yield. The authors
classified corporate governance practice by utilizing corporate governance
quotient (CGQ) a rating system designed to assist institutional investors in
evaluating the quality of corporate boards Verschoor (2004) studied the link
between corporate governance and financial performance using data of Standard
& Poors 500 companies who are mernbers of Ethics Officer Association (EoA).
According to Verschoor, it is believed that members of EOA practice superior
corporate governance in comparison to other S&P 500 companies who are not
members of EOA. The study found that EOA member companies reported a higher
Market value Added (MVA difference between market value and book value of debt
and equity) in comparison to non- members.

Thomspon and Chu (2003) conducted a research on the link
between corporate governance and financial performance on companies listed in
Singapore Stock Exchange. They constructed a corporate governance scorecard to
gauge the level of corporate governance of the companies based on the
companies’ annual report. Using regression analysis, they found that contrary
to what is expected, corporate governance has a negative relationship with
profitability denoted by return on equity.

 Another notable
research done in this area is research executed by Black et al. (2003) using data
of companies listed in Korea Stock Exchange. Similar to research method applied
by Thompson and Chu (2003, they constructed their own index consisting of 42
variables and regressed the corporate governance against financial performance.
Their findings suggest that corporate governance do explain the variation of
firm value or firm return within a country, and that is explanatory power is
greater in emerging markets than in mature ones.

 The findings of Black
et al. (2002) were further supported by Pitabas (2002) In his study of 113
companies listed in National Stock Exchange of India Limited Pitabas found that
corporate governance (gaged by 19 corporate governance measure) is positively
correlated with Tobin’s Q’ and excess stock returns.

 On the local front,
Khoo (2003) carried out a research to determine whether good governance is
indeed a contributing factor to firm performance. Khoo (2003) selected 32
companies whose shares are traded in Kuala Lumpur Stock Exchange. Corporate
governance standards of these companies are classified according to indices in
which companies listed in composite Index were assumed to practice better
corporate govemance compared to those companies who are second liners (non
composite index). The study revealed that companies in Composite Index has
higher rate of premium in comparison to companies in non composite index.
However, no clear distinction could be arrived on the relationship between
corporate govemance practices and return on assets between companies in
composite index and non composite index.


Tobin’s-q or simply q  compares the value ofa company given by
financial markets with the value of company’s assets. His calculated by Tobin
s-a or simply q ofis asses dividing the market value ofa company by the
replacement value of its assets.

2.5.2 selected Corporate Governance Practices and Financial

 Most of the
researches which attempt to find the linkage betwee corporate governance
practices and financial performance have opted to use selected corporate
governance practices rather than constructing a governance index. This is
further purported by Black et al. (2003) who stated that many existing
researches concentrated on a particular aspect of corporate governance such as
board, shareholders activism, compensation, anti-takeover  provision, investor protection and so on. The
undertying motive for using this methodology can be attributed to the fact that
certain corporate governance practices deemed to have more influence towards financial
performance of a company . According to Patterson (2003), the main attributes
of corporate governance that have been utilized in identifying the link are as

Antitakeover Pravisions

Board and Directors

 Corporate Crime

Corporate Leadership

Corporate Ratings

Executive Compensation

 Government Rules and

Insider Trading

Institutional Investors

Investor Protection

Ownership Structure

Shareholder Proposals