The Moderating Effect Of Risk Management Committee On Corporate Governance And Financial Performance

Corporate governance and corporate financial performance

A good board governance structure has been recognized as a central feature of modern corporations today as it is one of the determinants that leads to superior financial performance. A company which embraces a good board structure is in a strategic position to manage environmental, social and governance (ESG) issues in achieving superior financial returns including a higher rate of return and larger profit margins. Haniffa and Cooke ( 2005) commented that financial disclosure practices emanate from the board members, thus, the board structure constitutes a fundamental part of the corporate governance mechanism. Given such a scenario, it is crucial to consider the capacity of the board members in discharging their responsibilities. Board diversity, defined as the dissimilarities in the board attributes ( Frias‐Aceituno et al., 2013). According to Van der Walt and Ingley ( 2003), diversity among board members can be distinguished by age, ethnicity, industry background and gender. The diversity to boardroom is one of the methods to strengthen the internal governance structure and to protect investors’ interests ( Ngu & Amran, 2019). Additionally, the strength of diversity among board members has been discussed by Bing and Amran ( 2017) and Ngu and Amran ( 2018).

There is widespread debate about the board diversity as it can enhance board effectiveness, and, thereby, improve business performance. Empirical research has variously reported negative, positive, and no relationships between board diversity towards business performance. For instance, Reguera-Alvarado et al. ( 2017) reported a positive impact of gender diversity towards financial achievement in Spain. It was supported by Miller and del Carmen Triana ( 2009), they also found that financial achievement was influenced by gender diversity. Additionally, Mahadeo et al. ( 2012) focused the impacts of diverse boards on the financial benefits of PLCs in Mauritius. Their findings reported a satisfactory extent of heterogeneity with respect to age, educational background, independent board and financial benefits, however, women were poorly represented on the boards. In contrast, Carter et al. ( 2010) reported an insignificant relationships among ethnic diversity, gender diversity, and corporate excellence in US.

In the Malaysian context, Ganesan et al. ( 2018) conducted research on manufacturing industry and found no evidence to support the business performance was influenced by gender diversity, size of board and independent board. Zabri et al. ( 2016) also explored the corporate governance practices affecting corporate excellence among the largest 100 PLCs and concluded that return on equity was not affected by size of board. However, return on assets was negatively influenced by board size. Their findings demonstrated the insignificant link between independent board and superior financial returns.

Corporate governance, risk management committee and corporate financial performance

The RMC is receiving growing attention in this sustainability world, as the RMC establishes risk strategy, reviews risk reports and provides enterprise risk management advice to board members ( KPMG, 2001). Companies, however, differ in their processes and approaches they adopt towards controlling risks. Traditionally, an audit committee has been appointed to carry out the risk management duties ( Korosec & Horvat, 2005). However, in the era of increasing concern about sustainable development, the function of the RMC has increasingly gained recognition for managing sustainability risks and opportunities. Based on RBV standpoint, the RMC is a governance support mechanism. They assist board members to execute risk management duties, even though, ultimately, the board members are responsible for risk management ( ASE, 2007).

In the Malaysian context, Abdul Rahman et al. ( 2013) found that the board members involved in formulating and executing risk management policies among Malaysian Islamic banks was significantly higher than in Egypt. While the results of Ling et al. ( 2014) showed that RMC positively impacts board size, leverage and firm size. There is an increasing trend that the board members have assigned the financial reporting duties to the audit committee, whereas risk management oversight duties have been assigned to the RMC. The reason is that the risk management oversight responsibilities require an understanding of company-wide processes and structures. An effective RMC can assist board members to enhance their financial reporting, and, thereby, safeguard their reputation and attain their financial objectives ( Subramaniam et al., 2009).

Resource-based View (RBV)

From the RBV perspective, firm’s human capital resources are fundamental to developing a business competitive advantage ( Barney, 1997). Dichter ( 1995) claimed that many companies have underutilized human capital resources, such as racial backgrounds, female and diverse ethnic, which might contribute to the various suggestions to their businesses. By utilizing these unique resources effectively and efficiently, it can improve boards’ decision-making and financial performance. Moreover, it is well documented that diverse boards could assist management in responding to the needs and expectations of diverse stakeholders and enhancing corporate reputation ( Bear et al., 2010).

Another research conducted by Robins and Wiersema ( 1995), revealed that a company can use the firm’s internal resources effectively to build a competitive advantage that can be reflected in the return on investment. Nakabiito and Udechukwu ( 2008) also confirmed that the business success and failure is dependent on the business leaders making proper use of its internal resources. As such, it is crucial that board members should comprise directors with different experience, gender, ethnicity, and age. This is the main reason that the RBV is applied to analyse the moderating impacts of RMC on corporate governance towards financial achievement in Malaysia.

Research model

Figure 01 summarises the research model of this study, five corporate governance factors (e.g. board size, gender diversity, independent board, director experience and foreigner diversity) determining the financial performance. Additionally, the risk management committee was proposed to test the moderating effects in those relationships.

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Hypotheses development

Data collection

The content analysis was undertaken to obtain data from the corporate annual reports in year 2016. The data extracted from the corporate annual reports were gender diversity, board size, director experience, independent board, foreigner diversity, risk management committee, firm size, industry, and financial performance. Each company was identified as a unit of analysis.

Sample size

The sample size comprises the largest 100 listed companies by the market capitalization. Of the top 100 companies, 7 companies were taken from construction and REIT, 12 companies were selected from consumer goods, 10 companies were chosen from industrial products, 15 companies were taken from finance, 8 companies were chosen from plantations, 2 companies were selected from technology, 34 companies were taken from trading services, 4 companies were chosen from infrastructure project companies, and 8 companies were selected from properties.

Inter-coder reliability

This study employed a multiple-coder approach to test the reliability of data gathered and the consistency among two coders ( Milne & Adler, 1999). The result of Krippendorff’s alpha was 0.82, which revealed that an acceptable level of content analysis reliability and no significant differences between scores obtained ( as cited in Hayes & Krippendorff, 2007).

Measurement of variables

The financial performance was assessed by ROE and ROE ( Mahadeo et al., 2012; Zabri et al., 2016). While ROE measures the shareholders’ return (profit after tax ÷ total equity), ROA assesses the efficiency of assets (profit after tax ÷ total assets). This study proposed five corporate governance determinants (i.e., gender diversity, board size, director experience, independent board, and foreigner diversity) contributing to superior financial outcomes. The board size was measured using total directors sit on the board ( Hafsi & Turgut, 2013). The number of external directors over total directors was employed to assess the independent board ( Cheng & Courtenay, 2006). The gender diversity was assessed by percentage of female directors over board size ( Carter et al., 2010). Director experience was assessed by the proportion of directors who have a traditional experience (e.g. financial, consulting, or legal) and non-traditional experience (e.g. government, academia, or NGOs) over board size ( Strandberg, 2008). The percentage of foreign directors over total directors on board was employed to assess the foreigner diversity ( Hafsi & Turgut, 2013).

The moderator is RMC in this study; a dummy value of ‘1’ indicates that the company has a RMC or an audit committee joined with RMC, while a dummy value of ‘0’ otherwise ( Yatim, 2010). Following the academic studies in the corporate governance context, firm size and type of industry were introduced as control variables. For instance, Mak and Li ( 2001) revealed that the business performance was influenced by firm size. The total assets published in the annual report was utilized to examine the firm size ( Cheng & Courtenay, 2006). This study classified industries into two types: environmentally sensitive industries (construction and real estate, industrial products, plantations, properties, consumer products and infrastructure project companies), which use the value of ‘1’, and non-environmentally sensitive industries (finance, technology, and trading services), which take the value of ‘0’.

Analysis

The Smart-Partial Least Squares version 3.0 was used for data analysis. The next section discussed the empirical findings. While the reliability and validity of study variables were assessed in the measurement model, the proposed hypotheses were examined in the structural model.

Descriptive analysis

The ROE and ROA were employed to assess the corporate financial performance. While the ROA had a mean (standard deviation) of 10% (15%) and a minimum (maximum) of -19.50% (75%), ROE had a mean (standard deviation) of 24% (49%) and a minimum (maximum) of -45% (431%). Most of the sample companies had an average 9 directors sit on the corporate board whereas the minimum (maximum) board size was 4 (18), and the standard deviation was 2. For independent board, the maximum (minimum) percentage of external directors on corporate board was 78% (23%), while, on average, most of the companies had 48% external directors on corporate board.

For gender diversity, the minimum (maximum) proportion of female to serve on corporate board was 10% (50%) and the standard deviation (mean) was 12% (15%). With regard to director experience, the mean (standard deviation) was 24% (19%) and the minimum (maximum) was 0% (75%). For foreigner diversity, the minimum (maximum) proportion of foreign nationality on the board was 0% (70%), while, on average, most of the sample companies had 15% foreign nationality on the board. Meanwhile, around 11% of listed companies did not have a RMC; 89% of listed companies either had a RMC or an audit committee joined with RMC. With regard to industry, 51% of listed companies were environmentally sensitive, whereas 49% were non-environmentally sensitive. The average firm size was 40,661,183,825, a minimum (maximum) of 520,841,000 (735,956,253,000), and a standard deviation of 100,242,668,852.

Measurement model

The measurement items are reflective indicators for this current study. The risk management committee, board size, gender diversity, director experience, board independence, and foreigner diversity are single-item measures. The financial performance was assessed by ROE and ROA. Hence, the present study must examine the reliability and validity of the financial performance construct. Cronbach’s alpha and composite reliability (CR) were employed to test the internal consistency reliability, whereas convergent validity was analysed by average variance extracted (AVE). While the loadings and AVE were above 0.5, the Cronbach’s alpha and CR were above 0.70 (Table 01 ). These results demonstrated that the internal consistency reliability and convergent validity were satisfactory ( Hair et al., 2016). The heterotrait-monotrait ratio (HTMT) of correlations was employed to assess the discriminant validity. Table 02 presents the results of the HTMT values were lower than 0.85 ( Henseler et al., 2015). Therefore, the findings of the HTML criterion achieved the discriminant validity.

Structural model

The correlation between constructs can be analysed in the structural model. The lateral collinearity issues can be measured by variance inflation factor (VIF). As shown in Table 03 , all the values were lower than 5 ( Hair et al., 2016), thus, collinearity is not an issue. The predictive accuracy of this research model was assessed by coefficient of determination. The R² value of this study was 0.311, which indicated that corporate governance characteristics explained 31.1 percent changes in the level of financial performance. Therefore, R² for this study was classified as substantial ( Cohen, 1988). Additionally, this study also measured the effect size (f²) of the corporate governance characteristics on financial achievement. According to Kenny ( 2018), the variables that presented larger effect size (f²>0.025) to financial performance, were board size (f² >0.039), gender diversity (f²>0.076), and foreigner diversity (f²>0.261). Meanwhile, board independence (f²>0.001) and director experience (f²>0.015) contributed a small effect on the financial performance. Furthermore, this study used the predictive relevance (Q²) to examine the predicted capability ( Henseler, Ringle, & Sinkovics, 2009). The Q² value was 0.258, which was greater than the zero ( Hair et al., 2016). Therefore, the present research model has predictive relevance.

This study applied bootstrapping to compute the t-value for examining the significance of the direct path relationships. Table 03 shows the findings of the direct path relationships. The board size was one of the critical determinant of corporate financial achievement, the finding was shown negatively significant (β= - 0.171, t=2.585, p=0.005). In addition, gender diversity revealed a significant correlation with the financial achievement (β=0.235, t=2.304, p=0.011). The links between director experience (β=0.439, t=4.124, p=0.000) and foreigner diversity (β =0.108, t=1.306, p=0.096), and financial achievement were found to be significant. Therefore, hypotheses H1, H3, H4, and H5 were supported. However, the board independence was not a significant predictor of financial performance in Malaysia. Thus, Hypothesis H2 was not supported.

Moderating effects

In this study, risk management committee was found to have insignificant impact on the direction and strength of the links between corporate governance characteristics and corporate excellence. Hence, hypotheses 6a, 6b, 6c, 6d, and 6e were not supported, as shown in Table 04 .