Corporate Governance and Contingency Theory: A Structural Equation Modeling Approach and Accounting Risk Implications

188 Pages·2015·2.84 MB·English

by  Abdul Ghofar

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