Does the efficiency of corporate governance and intellectual capital affect a firm's financial distress? Evidence from Egypt
| Date | 05 March 2020 |
| Published date | 05 March 2020 |
| DOI | https://doi.org/10.1108/JIC-06-2019-0143 |
| Pages | 403-430 |
| Author | Tamer Mohamed Shahwan,Ahmed Mohamed Habib |
| Subject Matter | Information & knowledge management,Knowledge management,HR & organizational behaviour,Organizational structure/dynamics,Accounting & Finance,Accounting/accountancy,Behavioural accounting |
Does the efficiency of corporate
governance and intellectual capital
affect a firm’s financial distress?
Evidence from Egypt
Tamer Mohamed Shahwan
Department of Management, Faculty of Commerce, Zagazig University,
Zagazig, Egypt, and
Ahmed Mohamed Habib
Department of Accounting, Faculty of Commerce, Zagazig University, Zagazig, Egypt
Abstract
Purpose –Using data on 51 firms traded in the Egyptian Exchange from 2014 to 2016, this paper aimed to
assess the efficiency of corporate governance (CG) and intellectual capital (IC) practices and to explore their
influence on the probability of a firm’s financial distress.
Design/methodology/approach –The relative efficiency of CG and IC practices has been measured under
the Malmquist data envelopment analysis model. A modified Z-score model was applied to assess firms’
financial distress.
Findings –The Wilcoxon signed-rank test revealed almost insignificant evidence regarding the improvement
of CG and IC efficiency over the study period. The efficiency score of CG practices had no impact on the
likelihood of financial distress. However, the efficiency score of IC negatively affected the probability of
financial distress.
Research limitations/implications –The integration of data envelopment analysis with Tobit regression
was required for identifying the significant drivers of efficient CG and IC.
Practicalimplications –The findings shedlight on the role of CG and IC in alleviating the degree of financial
distress in Egypt as an emerging market, especially the need to raise firms’compliance with the Egyptian CG
code from a voluntary to mandatory status.
Originality/value –This study, using Malmquist data envelopment analysis, is among the first attempts to
assess the relative efficiency of CG and IC practices and their effects on financial distress.
Keywords Corporate governance index, Intellectual capital performance, Relative efficiency, Financial
distress, Egypt
Paper type Research paper
1. Introduction
The existence of the “principal-agent problem”defined by Jensen and Meckling (1976) has
attracted the attention of numerous researchers and practitioners to investigate different
approaches for controlling conflict of interest between managers and shareholders. One of the
prominent approaches for handling such an agency problem is to adopt and implement the
best practices of corporate governance (CG). Many have sought to ascertain the quality of CG
practices and their role in improving a firm’s financial performance and minimizing different
types of risks, particularly the risk of financial distress (e.g. Manzaneque et al., 2016;Udin
et al., 2017;Nasir and Ali, 2018;Luqman et al., 2018). For instance, Gruszczynski (2006)
confirms the negative association between the adoption of CG best practices and the
likelihood of the firm’s financial distress. Mardnly et al. (2018) point out that the ownership
structure as one of the basic dimensions of CG positively affects the financial performance of
Syrian firms. As argued by Wang and Deng (2006) and Oteng-Abayie et al. (2018), the
adoption of high-quality CG mechanisms as a tool for controlling the agency problem tends to
sustain a high level of firm performance and preserve firms from the risk of financial distress.
Economic
convergence of
output club
403
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1469-1930.htm
Received 19 June 2019
Revised 6 October 2019
25 November 2019
Accepted 20 January 2020
Journal of Intellectual Capital
Vol. 21 No. 3, 2020
pp. 403-430
© Emerald Publishing Limited
1469-1930
DOI 10.1108/JIC-06-2019-0143
Moreover, Luqman et al. (2018) show that the voluntary adoption of CG attributes minimizes
the level of financial distress. However, Shahwan (2015) documents an insignificant negative
association between CG and the probability of financial distress. Pramudena (2017) also
concludes that the proportion of commissioners and the number of directors positively
influence the likelihood of financial distress.
In the context of intellectual capital (IC), numerous studies have also been directed to
examining the role of IC in enhancing financial performance and hence reducing the
likelihood of financial distress (e.g. Pour et al., 2014;Nadeem et al., 2016;Nawaz, 2017;
Cenciarelli et al., 2018). The key findings of these studies empirically support the role of IC as a
strategic asset in enhancing the firm’s competitiveness, the firm value, asset management
capabilities and hence minimizing the financial distress risk.
Another stream of literature has also been directed to investigate the association between
CG mechanisms and IC (e.g. Ho and William, 2003;Safieddine et al., 2009;Altuner et al., 2015;
Nadeem et al., 2017). The empirical findings of these studies are not conclusive as they show
mixed evidence regarding such association and their impact on firm financial performance.
For instance, Faisal et al. (2016) show that board composition has no impact on IC efficiency
while CEO duality and board meetings negatively affect IC efficiency. Moreover, board size
and director’s ownership positively affect IC efficiency.
Similarly, a high level of efficiency plays a critical role in achieving competitive advantage
and ensuring excellent performance. According to March and Sutton (1997), a high level of
efficiency may be key to ensuring the survival of any business organization. Failure to attain
this level adversely affects customers’expectations and their loyalty (Hackman and
Wageman, 1995;Armstrong et al., 1997;Cook and Verma, 2002;Evans, 2011). Shenher et al.
(1997) argued that project efficiency is one of the four major dimensions required for
assessing the degree of project success. As documented by Serrador and Turner (2014),
project efficiency is correlated to 0.6 of a project’s overall success. In addition, an accurate
estimate of efficiency tends to drive decision-makers to optimize the use of their
organizational resources by enhancing either pure technical efficiency or efficiencies of
scale. As a result, much effort has been exerted to measure the relative efficiency of firms[1] in
various industries via data envelopment analysis (DEA) as an alternative to accounting
indices[2]. In the retail industry, Barros (2006) and Gandhi and Shankar (2014) have written
papers; in banking, Luo et al. (2012) and Shahwan and Hassan (2013); among health workers,
Asanduluia et al. (2014); in libraries and universities, Essid et al. (2010) and Shahwan and
Kabe (2013); and in the airline industry, Hong and Zhang (2010);Fuentes (2011). However, to
the best of our knowledge, no study has been conducted to investigate how a firm’s relative
performance in CG and IC influences financial distress, especially in developing countries
such as Egypt.
In Egypt (as an emerging market), a shift was observed in 1991 from the domination of a
central market economy to the adoption of a free market. One of the most important effects of
this economic transformation has been the increased interest in the level and quality of CG
practices within Egyptian corporations. In early 2001, through a joint project between the
World Bank and the Ministry of Foreign Trade, the quality of CG practices was assessed in
the light of the best practices formulated by the Organization of Economic Cooperation and
Development (OECD) (Shahwan, 2015). In view of these developments, a voluntary Egyptian
code was issued in 2005 by the Egyptian Institute of Directors (Ebaid, 2011). Later, in October
2006, the Egyptian Businessmen’s Association also issued a CG guide for family companies,
which was the first guide in Egypt and the Middle East for family business governance
seeking to develop sustainable business practices (Egyptian Institute of Directors [EIoD],
2016). Then, in 2011, the Egyptian Institute of Directors (EIoD) issued the first amendment to
the CG code of 2005, so as to keep up to date with the best practices at the regional and
international levels. A second update was introduced by the EIoD in August 2016, in order to
JIC
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