David Laing

Internal and External Governance Mechanisms: Their Impact on the Performance of Large UK Public Companies

This paper analyses the relationship between internal and external corporate governance mechanisms and the performance of UK companies within the context of the Cadbury Committees Code of Best Practice. The results show, first, that the market for corporate control is an effective governance mechanism that may be regarded as a substitute for the other mechanisms. Second, there is a weak relationship between the internal governance mechanisms and performance. Third, there is also little evidence that with firms in the top and bottom performance deciles have different internal governance characteristics. The results therefore raise questions about the efficacy of imposing prescriptive internal governance mechanisms on companies, particularly given that the market for corporate control has been shown to be an effective means of reducing agency costs.

Governance structures, size and corporate performance in UK firms

Analyses the extent of Cadbury compliance and its impact on corporate performance in the UK. Comparing 1992 and 1995, we find that UK public companies have, in general, complied with the Cadbury Committee’s Code of Best Practice and have adopted the recommended governance structures. However, compliance is more common among larger firms. Thus we find that duality is less common, firms tend to have more than three non‐executive directors and that there has been an almost universal adoption of board subcommittees such as the remuneration and audit committees. However, little evidence is found to suggest either that the board characteristics recommended by Cadbury lead to improved performance or that moving towards them improves performance. The only governance mechanism which does positively affect performance is the presence of remuneration and audit committees.

The performance-governance relationship: the effects of Cadbury compliance on UK quoted companies.

This paper investigates the extent to which recommendations madeby the Cadbury Committee have affected UK company performance.The Committee recommended that certain internal monitoringmechanisms should be adopted by quoted firms because they weremore effective than others as a means of promoting shareholderinterests. The mechanisms analysed are duality, the number ofoutside directors on the board and the presence of a remunerationcommittee. We analyse the relationship between governancestructures and performance for two years, 1992 and 1995. Usingsamples of 200 companies for each of the years, we find that theproportion of firms adopting the governance structuresrecommended by Cadbury has increased. However there is mixedevidence that the structures are associated with betterperformance. Depending on the choice of dependent variable, thepresence of a remuneration committee has a positive effect onperformance and outside director representation has a negativeeffect. However, there is evidence of a simultaneous relationshipbetween outside director representation and performance, a resultconsistent with additional outside directors being appointedafter a period of poor performance. Complete compliance with themodel of governance proposed by the Cadbury Committee does not,however, appear to be associated with performance which is betterthan that achieved by either partial or non compliance.

Governance structures, director independence and corporate performance in the UK

A number of Committees have been set up in recent years to investigate the governance of UK quoted companies. The key one was the Cadbury Committee, which recommended a number of governance structures as examples of best practice. These included the separation of the posts of CEO and chairman, a significant representation of non‐executive directors, the importance of non‐executive director independence and the setting up of board subcommittees. This study finds that there has been widespread adoption of the recommended governance structures. However, there is no clear relationship between governance structures and corporate performance. This raises questions about the most effective type of governance mechanism and whether or not the prescriptive recommendations of Cadbury should be replaced with a more flexible approach.

Incentive Effects, Monitoring Mechanisms and the Market for Corporate Control: An Analysis of the Factors Affecting Public to Private Transactions in the UK

This paper investigates the factors that influence the decision to change the status of a publicly quoted company to that of a private company. We find that firms that go private are more likely to have higher CEO ownership and higher institutional ownership. In relation to their board structures, firms going private tend to have more duality but there is no statistical difference in the proportion of non-executive directors. They do not show signs of having excess free cash flows but there is some evidence of lower growth opportunities. We do not find that firms going private experience a greater threat of hostile acquisition. The results are therefore consistent with incentive and monitoring explanations of going private. Calculation of the probability of going private shows that incentive effects are stronger than the monitoring effects.

Undervaluation, private information, agency costs and the decision to go private

There is widespread anecdotal evidence that poor stock market performance is an important reason for taking a company private. The results support the perceived undervaluation hypothesis. The finding also applies to management buy-outs, which indicates that the management of these firms had private information. It is also found that firms going private had non-optimal governance structures, higher board and institutional ownership. The last finding is consistent with going private transactions providing institutions with a means of existing firms with poor market valuation, particularly during a time of very limited pressure from the market for corporate control.

Ownership structure, board composition and the market for corporate control in the UK: an empirical analysis

This paper analyses the board composition and ownership structures of a sample of companies that have been acquired and those of a matching control sample that have not. We find significant governance differences between acquired firms and the control sample. Firms with the following characteristics were more likely to be acquired: they had the same person acting as CEO and chair, a higher proportion of non-executive directors, larger institutional shareholdings and higher director shareholdings. An analysis of small firms also found evidence of higher CEO shareholdings. We also find that treating all take-overs as a single group leads to a model mis-specification which does not identify the incentive effects of board and CEO shareholdings present in non-hostile acquisitions. These results are consistent with two agency-derived hypotheses, financial incentives and effective monitoring. We also find that targets exhibit lower growth potential but do not have worse accounting performance.

An Empirical Analysis of the Impact of Corporate Governance Mechanisms on the Performance of UK Firms

The agency model provides a number of ways to address the problems raised by the separation of ownership and control in public limited liability companies. In its Code of Best Practice, the Cadbury Committee proposed a variety of monitoring mechanisms which, if implemented, should improve corporate governance. As part of the Code, it was recommended that firms should have adequate non-executive director representation. They should also appoint an audit committee, the primary purpose of which was to monitor the auditing controls of the company. The extent to which these structures influence performance is analysed. In addition, we analyse the structure and calibre of audit committee membership and its effect on the performance of 312 large UK quoted companies. The effectiveness of the market for corporate control is investigated by means of take-over intensity by sector. We find that neither the independence of the committee membership nor the quality of the committee members has an effect on performance. However, we find that take-over intensity is negatively related to performance. This suggests that external control mechanisms are more effective than internal ones. When performance is split into deciles, there is some evidence that non-executive director independence and the market for corporate control are substitute governance mechanisms.

Corporate performance and the influence of human capital characteristics on executive compensation in the UK

The issue of executive pay has been the subject of intense debate in recent years. Discusses the factors determining executive pay using 1995 and 1996 data for a sample of 125 of the largest UK companies. Combines company performance and human capital characteristics as determinants of executive pay. Confirms the importance of company size as a strong influence on executive pay. Shows that profitability is a weak determinant of pay. Although human capital characteristics affect executive pay, the influence is not strong. When industry differences are taken into account, the impact of human capital diminishes further.

Management buy‐outs: the impact of ownership changes on performance

Management buy‐outs bring about a change in status of the management team from employee to owner. According to the “agency model”, this change in status provides the financial incentives necessary to ensure that company performance will improve post‐MBO. The key financial incentive present is that the rewards of better performance now accrue to the management team rather than to the previous owners. The “agency model” argues that having a significant financial stake in a company will militate against discretionary behaviour by the new owners. A sample of small management buy‐outs was analysed in terms of two performance indicators, cash management and profitability. Performance was measured against three benchmarks: prior company performance, the performance of companies of similar size and the performance of the industry average. In general, there is no real evidence of better cash management but there is some evidence of improved profitability. The results therefore, offer limited support for the role of incentives proposed by the agency model.