Model 3 Results and Discussion
ED Proportion 0.0369 0.045 0.1322 0.1291 −K. Kab]** −K. Ka__**
(0.1245) (0.1283) (0.0873) (0.0862) (0.0179) (0.0179)
Board Size −11.7924 −12.8521 4.1979 4.5033 −1.5435 −1.6385
(17.6049) (18.1991) (6.3612) (6.4741) (1.3805) (1.3856)
ED Ownership 0.215 0.2101 0.07 0.0714 0.0167 0.017
(0.1897) (0.1753) (0.0993) (0.0992) (0.0142) (0.0143)
NED Ownership 0.2487 0.2557 0.1493 0.1533 −0.0005 −0.0005
(0.2058) (0.2069) (0.1080) (0.1068) (0.0283) (0.0284)
Busyness 0.066 0.098 0.1453 0.1557 −0.0349 −0.0383
(0.1488) (0.1491) (0.1177) (0.1214) (0.0252) (0.0255)
Interlock −0.1313 −0.107 0.2333 0.2372 −0.0398 −0.04
(0.1327) (0.1310) (0.1608) (0.1629) (0.0470) (0.0472)
Industry None None Yes Yes Yes Yes
Years Yes Yes Yes Yes Yes Yes
Wald’s Test 2.26*** 2.31*** 1.84*** 1.86*** 1.81 1.59
BPLM Test 27.48*** 28.00*** 33.78*** 34.00*** - -
LR Test - - - - 83.66*** 82.28***
Hausman Test 63.04*** 66.60*** 14.66 15.86 - -
Chi2 1.52* 1.50 103.76*** 109.08*** 49.82*** 50.21***
Appropriate Model Fixed Effects Fixed Effects Random Effects Random Effects Random Effects Random Effects
Observations 651 651 651 651 651 651
Table 10
Panel Estimation Results: Firm Performance and AC Chair That is NSID
The dependent variable is Firm Performance, as measured by ROA, ROE, or NEGPROF. ROA is computed as net income plus interest expenses net of tax effects (EBIAT) divided by the book value of assets of the previous period; ROE is computed as EBIAT divided by the book value of equity of the previous period; NEGPROF is a dummy variable equal to 1 when the firm’s EBIAT is negative and 0 otherwise. ACNSIDCHAIR a dummy variable that takes the value of 1 if the audit committee’s chair is a non-strict independent director and 0 otherwise; TopOwn is the percentage ownership of the largest shareholder; Firm Size is the natural logarithm of the book value of total assets; Growth Opportunities is proxied by the one-period lagged market-to-book asset ratio; Leverage is the ratio of long-term debt to total assets; Firm Age is the natural logarithm of the number of years since the firm’s date of incorporation; CEO Duality is a dummy variable that takes on the value of 1 when the CEO is also the Chair of the board and 0 otherwise; ED Proportion is the proportion of executive directors on the board; Board Size is the natural logarithm of the number of directors on the board; EDown is the percentage of outstanding shares owned by executive directors; NEDown is the percentage of outstanding shares owned by non-executive directors; Busyness is the ratio of the number of busy non-executive directors to board size; Interlock is measured as the ratio of the number of interlocked executive directors to board size. The test statistics of the various specification tests are also reported. BPLM test is the Breusch-Pagan Lagrange Multiplier used to test for random effects; Wald’s test is used to examine whether there are fixed effects; Hausman test is used to determine whether the random effects model suffers from biased and inconsistent estimates; LR Test is analogous to the BPLM test but for logistic regressions. The results of these tests indicate that the Fixed Effects model is appropriate for regression models 1 to 4, while the random effects logistic model is appropriate for models 5 and 6. The coefficient estimates for columns 5 and 6 are the average marginal effects. Figures in parentheses are cluster-robust standard errors. *** denotes significance at the 1% level; ** denotes significance at the 5% level; and * denotes significance at the 10% level.
Dependent Variable ROA ROE NEGPROF
Variable 1 2 3 4 5 6
ACNSIDCHAIR −^. ONO]* −MM. _K_`* −1.0778 −0.5722 −0.505 −0.205
(3.1954) (6.0573) (2.5871) (6.2038) (0.4833) (1.0789)
TopOwn 0.1194 0.0789 −0.0223 −0.0172 −0.0047 −0.0017
(0.1019) (0.1034) (0.0567) (0.0775) (0.0126) (0.0157)
ACNSIDCHAIRS x
TopOwn 0.1059 −0.0094 −0.006
(0.0951) (0.0931) (0.0194)
Firm Size −2.0016 −2.0184 N. MObM*** N. MOa_*** −K. bbOb*** −K. bOM^***
(1.5815) (1.5833) (0.7795) (0.7740) (0.1824) (0.1826)
Growth Opportunities 4.6085 4.5828 −0.1162 −0.1103 K. ]Mb^* K. ]NKb*
(3.1685) (3.1512) (2.3723) (2.3693) (0.2173) (0.2173)
Leverage K. Mb_N* 0.177 0.0972 0.0974 −0.0135 −0.0131
(0.1090) (0.1134) (0.1179) (0.1176) (0.0176) (0.0176)
Firm Age 3.071 2.2024 0.6481 0.6525 −0.1943 −0.188
(9.2678) (9.0718) (1.7304) (1.7202) (0.4185) (0.4186)
CEO Duality −4.9425 −4.4879 −4.7477 −4.759 0.8913 0.886
(4.6257) (4.6963) (3.0753) (3.0733) (0.5697) (0.5697)
ED Proportion 0.0844 0.0877 0.1365 0.1369 −K. Kab`** −K. Kab]**
(0.1047) (0.1075) (0.0877) (0.0864) (0.0179) (0.0180)
Board Size −11.6929 −11.9646 5.3894 5.3696 −1.7074 −1.7208
(18.3032) (18.6823) (6.7514) (6.7799) (1.4256) (1.4247)
ED Ownership 0.2162 0.2104 0.0711 0.0713 0.0181 0.0183
(0.1740) (0.1700) (0.0987) (0.0986) (0.0139) (0.0139)
NED Ownership 0.2939 0.2844 0.1547 0.1547 0.0044 0.0046
(0.2137) (0.2142) (0.1136) (0.1139) (0.0281) (0.0282)
Busyness 0.0842 0.0939 K. NKbO* K. NKb`* −0.0402 −0.0406
(0.1500) (0.1502) (0.1219) (0.1229) (0.0260) (0.0261)
Interlock −0.1018 −0.0951 0.2483 0.2485 −0.0493 −0.0487
(0.1233) (0.1247) (0.1601) (0.1605) (0.0488) (0.0487)
Industry None None Yes Yes Yes Yes
Years Yes Yes Yes Yes Yes Yes
Wald’s Test 2.26*** 2.26*** 2.09*** 1.91*** 1.23 0.72
BPLM Test 35.67*** 35.92*** 36.63*** 36.63*** - -
LR Test - - - - 81.10*** 80.58***
Hausman Test 56.87*** 57.40*** 15.48 15.51 - -
Chi2 1.51 1.42 100.99*** 108.52*** 48.40*** 48.37***
Appropriate Model Fixed Effects Fixed Effects Random Effects Random Effects Random Effects Random Effects
Observations 640 640 640 640 640 640
We further investigate the impact of non-strict independent directors on firm performance through their role in the audit committee in Model 3. Results of estimating Model 3 are shown in Tables 9 and 10. Table 9 reports the results when the proportion of non-strict independent directors in the audit committee is the independent variable of interest while Table 10 reports the effect of non-strict independent audit committee chairs on firm performance.
Results in columns 1 and 2 of Table 9 indicate that the proportion of non-strict independent directors in the audit committee is negatively related to firm performance. These findings support the agency theory, which posits that non-strict independent directors are appointed not to enhance firm value through proper board oversight and monitoring, but to create an environment that is friendlier towards management, which leads to lower performance.
Results in Table 10 point to a similar inference. Specifically, there is some evidence that if the audit committee chair is a non-strict independent director, then firm performance is lower, similar to the findings of Crespi-Cladera and Pascual-Fuster (2014).
However, an examination of the interaction term between ownership concentration and the proportion of non-strict independent directors in the audit committee in Table 9 shows that this coefficient is positive and statistically significant. Thus, although a higher proportion of non- strict independent directors in the audit committee negatively affects firm performance, this negative effect is lower for firms with high ownership concentration, similar to our findings from estimating Model 2. Taken together, these results seem to suggest that while the presence of non- strict independent directors in the audit committee may be indicative of some form of agency problem among firms with a dispersed ownership structure, the same cannot be said for firms with higher ownership concentration, which characterizes most Philippine publicly listed firms.
Conclusion and Recommendations
Board independence is an important topic in the corporate governance literature because of the supposed benefits it confers to both the shareholders and the firm. Independent directors are meant to provide industry expertise and experience to less experienced board members and managers, and they ideally protect minority shareholders from wealth expropriation by either management or large shareholders. However, among Philippine publicly listed firms, we find that an average of 50.99% of independent director positions are occupied by non-strict independent directors, and that 50.48% of the individuals who are declared independent directors are non-strict independent directors. This makes it more likely for board independence to be an ineffective corporate governance mechanism for preventing wealth expropriation by management or large shareholders.
Using an unbalanced panel of 926 firm-years for the period 2012 to 2015, we find significant evidence that firms with concentrated ownership are more likely to have a non-strict independent director on the board. Moreover, using an unbalanced panel of 669 firm-years for the period 2012 to 2015, we find that the proportion of non-strict independent directors has an insignificant effect on firm performance, regardless of the firm performance measure used. These results indicate that publicly listed firms with concentrated ownership in the Philippines do not appoint non-strict independent directors to mask some agency problem but to satisfy regulatory requirements while achieving the optimal level of board independence, consistent with the optimal board independence theory.
We further investigate the impact of non-strict independent directors on firm performance through their role in the audit committee and find that the presence of these directors in the audit committee erodes firm value, which supports the agency theory. However, we also find evidence
that this negative effect on performance is mitigated for firms with higher ownership concentration. This leads us to conclude that firms with higher ownership concentration do not appoint non-strict independent directors to mask agency problems present in the firm; rather, their presence gives management some degree of flexibility to effectively govern the firm.
Overall, we find some evidence in support of the optimal board independence theory for firms with higher ownership concentration. On the other hand, for firms with lower ownership concentration, non-strict independent directors erode firm value not through their presence on the board but through their involvement in the audit committee.
While our results suggest that the proportion of non-strict independent directors does not negatively affect firm performance, the case where independent directors are not strictly independent still exposes minority shareholders to the risk of wealth expropriation. Given that about half of the declared independent directors in Philippine publicly traded firms are not strictly independent, then the effectiveness of board independence as a corporate governance mechanism to protect the interests of minority shareholders is diluted. While the 2017 Philippine Code of Corporate Governance for Publicly Listed Firms requires firms to have policies on minority shareholder rights and privileges, the Code leaves the formulation of such policies to the firm.
Fortunately, the Corporation Code of the Philippines (Abrugrar, 2012) provides some degree of power for minority shareholders to ensure their representation on the board. The Corporation Code mandates that shareholders may cumulate their votes to increase the chances of their desired director being appointed and that directors who fulfill the right to representation of shareholders may not be removed without cause (Batas Pambansa Blg 68 - The Corporation
Code of the Philippines, 1980).17 Minority shareholders who band together to cumulate18 their shares increase their chances of board representation (Bhagat & Brickley, 1984); however, the effectivity of this practice depends on the degree of ownership concentration of the majority owners. On November 2017, the Securities and Exchange Commission of the Philippines raised the minimum required public float of listed companies to 20% from 10% for new entrants into the stock market with plans to gradually increase the public float of currently listed companies in the following years (Francia, 2017).19 This improves the chances that minority shareholders who cooperate will have legitimate representation in board matters. However, while this new requirement increases the chances of minority representation, the minority shareholders’ interest may still have little influence over board matters due to the number of directors who may be allied to the largest shareholders.
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Appendices
Appendix A: Evolution of Corporate Governance Codes in the Philippines
The first Code of Corporate Governance in the Philippines that was promulgated by the Securities and Exchange Commission (SEC) in 2002 defined an independent director is as follows (taken verbatim from SEC Memorandum No 16 Series of 2002, dated April 5, 2002, except for item g):
List A.1 – 2002 Code of Corporate Governance:
a. Is not a director or officer or substantial stockholder of the corporation or of its related companies or any of its substantial shareholders (other than as an independent director of any of the foregoing)
b. Is not a relative of any director, officer or substantial shareholder of the corporation, any of its related companies or any of its substantial shareholders. For this purpose, relatives include spouse, parent, child, brother, sister, and the spouse of such child, brother or sister;
c. Is not acting as a nominee or representative of a substantial shareholder of the corporation, any of its related companies or any of its substantial shareholders;
d. Has not been employed in any executive capacity by that public company, any of its related companies or by any of its substantial shareholders within the last five (5) years;
e. Is not retained as professional adviser by that public company, any of its related companies or any of its substantial shareholders within the last five (5) years, either personally or through his firm;
f. Has not engaged and does not engage in any transaction with the corporation or with any of its related companies or with any of its substantial shareholders, whether by himself or with other persons or through a firm of which he is a partner or a company of which he is a director or substantial shareholder, other than transactions which are conducted at arm’s length and are immaterial or insignificant.
g. Must not have beneficial security ownership of more than 10 percent of the company's outstanding shares.
The Code was revised in 2009 via SEC Memorandum No. 6 Series of 2009, dated June 22, 2009, and stipulated that independent directors may only own up to two% of the subscribed capital stock of the company covered by the Code or its subsidiaries and affiliates. In a subsequent memorandum (SEC Memorandum Circular No. 9 Series of 2009, dated June 24, 2009), the SEC included two additional criteria that independent directors must satisfy.
List A.2 – 2009 Revised Code of Corporate Governance:
a. A regular director who resigns or whose term ends on the day of the election shall only qualify for nomination and election as an Independent director after a two (2) year
“cooling-off period”;
b. Persons appointed as Chairman “Emeritus”, “Ex-Officio” Directors/Officers or Members of may Executive Advisory Board, or otherwise appointed in a capacity to assist the Board in the performance of its duties and responsibilities shall be subject to a one (1) year “cooling-off period” prior to his qualification as an Independent directors.
c. Must not have beneficial equity ownership of more than two percent of the subscribed capital stock of the covered company or its subsidiaries.
In 2011, the SEC introduced the following term limits for independent directors of all listed, public, and mutual fund companies (taken verbatim from SEC Memorandum Circular No. 9 Series of 2011, dated December 5, 2011:
List A.3 – 2011 Amendments to the 2009 Revised Corporate Governance Code:
a. There shall be no limit in the number of covered companies that a person may be elected as Independent director (ID), except in business conglomerates where an ID can be elected to only five (5) companies of the conglomerate, i.e., parent company, subsidiary or affiliate;
b. IDs can serve as such for five (5) consecutive years, provided that service for a period of at least six (6) months shall be equivalent to one (1) year, regardless of the manner by which the ID position was relinquished or terminated;
c. After completion of the five-year service period, an ID shall be ineligible for election as such in the same company unless the ID has undergone a “cooling off” period of two (2) years, provided, that during such period, the ID concerned has not engaged in any activity that under existing rules disqualifies a person from being elected as ID in the same company;
d. After service as ID for ten (10) years, the ID shall be perpetually barred from being elected as such in the same company, without prejudice to being elected as ID in other companies outside of the business conglomerate, where applicable, under the same conditions provided for in this Circular;
On November 26, 2016, the Code of Corporate Governance Code for Publicly Listed Companies was promulgated by the SEC. This new code applies only to publicly listed companies in the Philippines and took effect on January 1, 2017. It consolidates the criteria for independent directors from the 2009 Revised Code of Corporate Governance (as amended) and introduces a number of new criteria. The criteria for independence are as follows (items a to j are taken verbatim from the SEC Memorandum No. 19 Series of 2016, dated November 22, 2016, while item g is from SEC Memorandum No. 4 Series of 2017, dated March 9, 2017):
List A.4 – 2017 Code of Corporate Governance for Publicly Listed Companies
a. Is not, or has not been a senior officer or employee of the covered company unless there has been a change in the controlling ownership of the company;
b. Is not, and has not been in the company three years immediately preceding the election, a director of the covered company; a director, officer, employee of the covered company’s subsidiaries, associates, affiliates or related company’s subsidiaries, associates, affiliates or related companies; or a director, officer, employee of the covered company’s substantial shareholders and its related companies;
c. Has not been appointed in the covered company, its subsidiaries, associates, affiliates or related companies as Chairman “Emeritus,” “Ex-Officio” Directors/Officers or Members of any Advisory Board, or otherwise appointed in a capacity to assist the Board in the performance of its duties and responsibilities within three years immediately preceding his election;
d. Is not an owner of more than two percent of the outstanding shares of the covered company, its subsidiaries, associates, affiliates or related companies;
e. Is not a relative of a director, officer, or substantial shareholder of the covered company or any of its related companies or of any of its substantial shareholders. For this