The Relationship Between Corporate Governance Practices and Financial Performance in New Zealand: An Empirical Investigation

Corporate Governance is the set of structures and behaviours by which a company or other business entity is directed and managed (New Zealand Securities Commission, 2003). The structures and behaviours guide how the entity sets objectives, develops strategies and business plans, monitors and reports on performance, and manages risks. They also guide how directors and managers meet all expectations and that they are responsible and accountable in their respective roles. In 2004 the New Zealand Securities Commission (NZSC) adopted a principle-based corporate governance approach which was intended to contribute to high standards of corporate governance in New Zealand entities. The principles/guidelines are broad statement generally applied to the governance of entities that have economic impact in New Zealand or are accountable, in various ways, to the public. The economic entities are required to observe the principles/guidelines to the fullest extent that they reasonably can and depart only where they are subject to competing statutory or public policy requirements (NZSC, 2004). This thesis investigates the effect principle-based corporate governance practices have on the financial performance of publicly listed companies and public corporate entities in New Zealand. The adoption of the principle-based approach was to encourage entities to develop governance structures that are specific to their context. Therefore, this research examines: (i) whether the NZSC recommendations have encouraged institutions to develop entity and/or industry specific governance structures; and (ii) whether the differences in governance practices at entity and industry level contribute to the differences in the financial performance. Prior studies have examined governance practices of larger corporations in large economies. The governance practices of companies in smaller economies have received little attention. This research extends the understanding of responses to smaller entities, both private and public sector, in a small open economy with a mature capital market. The focus of this thesis is on the governance variables that have been highlighted by the NZSC in 2004 and also other governance variables that are supported in the literature as providing an appropriate structure for the institutions in the environment in which it operates. Data for the small and large capitalisation (cap) companies were obtained from the New Zealand Stock Exchange (NZX) Deep Archive. The data for the small cap companies covered the period 1999 to 2006 and for large cap companies the sampling period was from 1999 to 2007. For public sector corporate entities, data were obtained from their respective annual reports for the period 2000 to 2007. Pooled data were analysed using ordinary least squares (OLS) regression and two stages least squares (2SLS) regression techniques to evaluate: (i) whether entities have complied with the NZSC recommendations; (ii) whether those entities that were continuously compliant with the NZSC recommendations have superior financial performance; (iii) the entities’ financial performance post-NZSC recommendations is better than pre-NZSC recommendations; and (iv) the difference in governance practices in different entities and industries and the effect they have on company financial performance. The findings indicate that small cap and large cap companies and public sector corporate entities have universally adopted the Securities Commission recommendations. Results for the large cap companies show that compliance with NZSC recommendations had a positive effect on financial performance, but empirical results show that compliance with NZSC recommendations has had a negative effect on the financial performance of small cap companies and public sector corporate entities. There is also evidence that governance practices in certain industries have contributed towards the differences in entities’ financial performance. This suggests that a principle-based governance approach led to the development of industry-specific governance structures in large cap companies and State-Owned Enterprises (SOEs) as intended. However, the evidence for the small cap companies is specific to the finance/investment sector. As a result of this study, the relationship between ‘soft regulations’ and entities’ financial performance is better understood, and in terms of public/regulatory requirements, the issues associated with compliance cost burdens are better informed. This study offers insights for policy makers around the world who have adopted principle-based approaches and to those jurisdictions that are interested in adopting similar governance approaches in the future