Vol 13 (2016) - Issue 5

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Board Composition and Firm Performance: Empirical Evidence on Listed Companies in Hong Kong – Part One

1. Introduction
Corporate governance refers to the rules and procedures by which the management of a company is directed and controlled to maximise the company’s profitability for shareholders, while taking into account interests of other stakeholders. In modern companies, corporate governance issue arises from the separation of ownership and control. Agency theory (as hereinafter explained) suggests that managers may seek to maximise their personal interests rather than the interests of the company as a whole. Adequate monitoring, or good corporate governance, nevertheless, can reduce agency problems.
The board of directors, as the highest level decisionmaking body in a company, plays an important role in corporate governance. In light of their two main responsibilities, first, to approve managers’ decisions and monitor their performances, and second, to appoint and discharge managers, earlier researches on directors in the US, suggest that a board with a majority of non-executive directors is better able to monitor a company, as non-executive directors are more suitable for objective monitoring than executive directors, who are often less likely to challenge decisions of the senior management. Based on these US findings, firms should operate more efficiently by increasing the proportion of non-executive directors on their board.
The aim of this two-part paper is to analyse the effect of board composition, in terms of proportion of non-executive directors, on corporate performance in Hong Kong, where many companies are Family-owned or State-owned Enterprises (as hereinafter defined). My research finds that currently 86.5% of listed companies in Hong Kong have 31% to 50% of non-executive directors serving on their boards. This paper focuses to see whether the requirements related to non-executive directors in the Listing Rules (as hereinafter defined) of Hong Kong can benefit companies’ financial performance in addition to its transparency, and to provide basis for companies to enhance financial performance by changing their board composition.
This article will be published in two parts. This first part will examine board composition and corporate governance in three sections. First, it will study the theoretical framework based on agency theory and resource dependence theory to see how non-executive directors contribute to their monitoring and advising role of corporate governance. This paper will go on to discuss the regulatory background in relation to nonexecutive directors in both the UK and Hong Kong. Second, it will examine empirical researches conducted around the globe related to the effects of non-executive directors on company’s financial performance. The third and last section of the paper will then set out the data collection process and the methodology of my own empirical study to examine the relationship between board composition and firm performance for listed companies in Hong Kong. The second part of the paper will explore a further three sections. First, it will analyse the 266 constituent companies of the Hang Seng Composite LargeCap and MidCap Index in Hong Kong to verify the effects of non-executive directors on company’s financial performance. It will also analyse certain director affiliations to evaluate whether these factors, which prevent a director from being 'independent', affect firm performance individually. Second, this paper will try to give reasons explaining its particular results found in Hong Kong. The third and last section of Part Two will provide policy implications according to the results.