Stock return and financial performance as moderation variable in influence of good corporate governance towards corporate value | Emerald Insight

1. Introduction

The objective of this study is to evaluate how much influence good corporate governance (GCG) has on corporate value, as well as moderating effect of stock return and financial performance on the influence of GCG on corporate value. Goal of every company is to increase the amount of money shareholders receive. Maximum corporate value will result in increasing profit for shareholders (Husnan, 2012). Agency problem is an obstacle in achieving the goal. Agency problem is derived from separation between corporate ownership and corporate management. Professional managers who do not have any share or very little share in company are the ones responsible for running majority of large companies. As a result, these managers feel they have authority to run companies without taking shareholder’s interest into account. They are not foreign to ask for high salary and certain facilities.

Cornel and Alan mentioned three sources of agency problem: the first is manager’s tendency to ask for not only luxurious facilities and requirement but also rights to make strategic decision. The second is manager’s tendency to make risky investment. Most managers do not own any share in a company and therefore, do not have as much sense of belonging as shareholders. They do not take further consideration to use company profit for various investments. Because of their fixed salary and limited stock ownership, these managers do not spend optimum energy or pay maximum attention to run the company as much shareholders expected. The third source of agency problem is manager’s tendency to minimize risk resulting in company losing profitable investment.

Investor’s motive to make investment in stock market is to get return in the form of dividend or capital gain as well as company ownership. Prior to investment, investors will take stock return they are going to accept and corporate value into account. Stock price represents the corporate value of public companies. Higher stock price equals to higher corporate value (Husnan, 2012).

There are intensive discussions on dividend policy until recently. Arthur and David (1997) explained three basic perspectives about dividend: first, dividend policy is neither relevant nor requires specific estimation, second, the amount of dividend is linear to stock price and third, there is a negative correlation between dividend policy and stock price, meaning that lower dividend results in higher stock price. Miller and Modigliani’s (1961) dividend irrelevance theory states that dividend has zero influence on corporate value and has been a topic of some debates for the last four decades. Miller and Modiglaini’s refusal on the bird in the hand theory is the cause of these debates. Black (1976) called the debate dividend puzzle that until recently has left behind some unanswered questioned, namely, why do corporation pay dividend? And why do in investors pay attention to dividend?. Some experts, for example Feldstein and Green (1983), attempted to answer Black’s question explaining that company pays dividend in order to meet or accomodate: different shareholder’s preference on tax fee from each type of shareholder and shareholder’s tendency to conduct their investment portfolio to overcome uncertainty. Bortz and Rust (1984) postulated that dividend plays a significant role for investor to create a balance between risk and return from portfolio the investors have. Bhattacharya’s (1979) dividend signaling model stated that when there is asymmetric information between company and investor, dividend becomes mechanism or instrument that provides information for shareholders (investors). According to Black and Scholes (1974), there are three types of investor, namely, investor who prefers stock with high dividend yield, investor who prefers return from dividend and capital gain and investor who prefers stock with low dividend yield.

Financial performance shows how effective and efficient an organization is in achieving its goals. Effectiveness refers to the ability of management to select accurate goal or instrument to achieve specific goals. Efficiency refers to ratio between input and output in which suitable input will result in optimum output. Increasing financial performance becomes requirement for a company in order to attract investors. Published financial statement represents financial performance of a company. Financial statement is the final outcome of accounting process carried out in order to provide information about financial condition of a company. Investors or managers use the report to make decision about investment. Financial report provides “relatively raw data.” Managers need information, instead of raw data. The significance of financial reports depends on individuals who need them or when the reports are needed.

According to Brigham et al. (2007), in order to maximize corporate value, management should make use of strength and minimize weaknesses a company has. Financial analysis shows performance difference between companies in the same industry, and company’s current financial position or trend. This study helps management identifying weaknesses and finding solution to minimize or even eliminate them. Prior to making long-term investment, investor will analyze profitability, future prospect and risk of making investment a company has. Analyst needs certain indicators to make interpretation and run analysis on financial report of a company. The most frequently used indicator in financial analysis is “ratio.” Ross et al. (2009) described five kinds of frequently used financial ratio, namely, liquidity, activity, leverage, profitability and market value ratio. Brigham et al.’s (2007) return on equity (ROE) is one of the most important ratios for measuring the profitability of a company. ROE refers to net profit for shareholders divided by total shareholder equity. Shareholders expect high return from investment they made and ROE shows how much they get. High ROE will result in high stock price and activities of which purpose is to increase ROE which will also increase the stock price.

Stock market is a medium for the public to invest their money in the form of deposit, gold, piece of land or house. As an addition, public can also make investment in the form of stock or obligation. Investing in stock or obligation requires far less amount of money compared to investing in house or a piece of land. Stock market is a suitable place for people who are interested in making investment without having to spend a lot of money. Stock market will result in social welfare if it is stable, running well, has stable growth and not highly fluctuated. However, Indonesian stock market does not provide much contribution to the national economy. There are several cases that prove that the national stock market is not running well, for instance delisting issuers, price fraud and fraud that involve Duta Bank and Pikko Bank, two private banks in Indonesia (Samsul, 2006).

Both practitioners and academics agree upon the lack of awareness and understanding toward the principles of GCG as one of the reasons why Indonesian stock market does not have enough contribution toward the national economy. On the other hand, Asian Development Bank concluded two reasons that cause economic crisis in Asian countries in including Indonesia; they are ineffective in supervising the role of commissary board and audit committee of a company in protecting shareholder’s interest. It is expected that implementation of GCG in Indonesia increases professionalism and shareholder’s welfare without putting aside stakeholder’s interest.

Growing popularity of GCG in the last ten years is hard to deny. Not only is the terminology becoming more popular, but it also has been put in a respected position. First of all, GCG is one of the successful keys for company to grow, make long-term profit and win global business competition. Second, the unsuccessful implementation of GCG is believed to cause economic crisis in Asia and Latin America.

Having established Financial Services Authority or Otoritas Jasa Keuangan (OJK), Indonesia has reformed their financial sector supervision framework recently. The 2011 Decree number 21 is the regulation for the establishment of the Financial Services Authority or OJK. The new framework emphasizes on how important fundamental, sustainable and healthy financial system that is able to protect consumer and public interest is. Implementation of good practice of management is one of the main contributors to achieve the objective of the framework. Its successful implementation will result in increasing economic performance and sustainable economic growth (Muliaman, 2004).

Indonesia has participated in ASEAN Economic Zone in 2015 and therefore, there is need and motivation for Indonesian companies to improve their business activities and competitive advantage. In order to survive business competition in South East Asia, Indonesian companies should improve their management system, improve both financial and operating performance, increase investor’s level of trust and create access for investors.

Corporate governance aspects adopted Jensen and Meckling’s (1976) theory as the basis in order to create balance between management, shareholder and stakeholder’s interest. Perspectives of corporate governance actually consist of shareholder and stakeholder’s paradigm. This difference refers to understanding toward conception on purpose to establish a company that influences need for governance instrument. The perspective changes mindset of a company in which company should pay attention to shareholder and stakeholder’s interest because its activities will affect the society considering that the company has developed relationship with various organizations or institutions inside or outside the company. Therefore, trust and business ethics should become bases for this relationship.

Legal approach of corporate governance means that the key mechanism of corporate governance is protecting external investors, both shareholders and creditors, through the legal system, which can be interpreted by law and its implementation, although the reputations and ideas that managers have can assist in getting investment. Variations in law and its implementation are central to understanding why companies in some countries are more likely to get investment than other companies.

Some examples of vertical agency problem that occurs in Indonesia are asymmetric information (Alwy and Schech, 2004), profit manipulation (Herawati, 2008), excessive utilization of debt (Wiliandri, 2011) and reluctant to distribute free cash flow in dividends to shareholders (Mai, 2010). Horizontal agency problems in developing countries, including Indonesia, are caused by concentrated ownership (institutional shareholders), which further encourages controlling shareholders to expropriate minority shareholders (Alwy and Schech, 2004). In addition, the controlling shareholder can cooperate with managerial to override the interests of other shareholders or take advantage of their controlling power. On the other hand, institutional shareholders as controlling shareholders can more effectively monitor managerial behavior because they are more capable and have more professional resources than individual shareholders (Lotto, 2013).

Signaling theory states that a good company will deliberately signal the market, thus the market is expected to be able to distinguish between good and bad companies. An effective signal is one that market can capture and perceive. The quality of a company is demonstrated through GCG, which, in turn, will provide a signal by delivering the financial statements along with the corporate governance information achieved by the company in a certain period on time. The signal given by a good company is considered a good news but the signal given by a bad company is considered a bad news.

Dividend and capital gain are types of return investors are looking forward to and according to the residual theory of dividend, company establishes dividend policy after all profitable investments are financed. The paid dividend is a residual after all the profitable investment proposals have been financed (Hanafi, 2008). Companies that are still in their growth stage will require a significant amount of money to expand their business and one source of money to use is profit they have gained. If the company during its business expansion is using profit, it will reduce the amount of dividend distribution. According to Bender and Ward (2009), companies at the growth stage tend to set a relatively small dividend payout ratio compared to well-established ones.

Several previous studies discuss correlation between GCG and corporate value. Wahab et al. (2007) who observed 440 companies listed in Malaysian Stock Exchange found a significant increase in Corporate Governance Index and it had a significant influence on shareholder’s welfare measured using market to book value of equity. Connelly et al. (2012) revealed that corporate governance (Board Size, Board Independence) had a negative influence on corporate value (Tobin’s Q, ROA, Firm Size, Capital Expenditures, Financial Leverage, Corporate Index and Family Ownership). Jauhar (2014) stated that corporate governance (Independent Audit Committee Proportion, Independent Commissioner Proportion) had a significant and positive influence on corporate value (MBR, Tobin’s Q and Closing Price). Different from Wulandari Widaryanti (2009), Sulong and dan Mat (2008) argued that GCG did not have any influence on corporate value.

Based on the previous studies, it may be concluded that there is a gap between the influence of GCG on corporate value and influence of stock return toward financial performance, and moderating variable is needed to evaluate the influence of GCG on company performance, more particularly stock return and financial performance. This discrepancy creates opportunity for conducting an in-depth study on those variables.

This study is basically an extended replication from the previous studies. Its novelty is correlation between stock return and financial performance as moderation. Previous studies used these as mediating variables. This study is going to generate different finding as it is conducted in different setting (country where this study is conducted), type of industry, research period and using different method of analysis.

This study is conducted in public company listed in Indonesian Stock Exchange and LQ45 index between 2010 and 2016. The companies listed in the LQ45 index were selected as object of the study because their stocks will return and they have good performance and fundamental (blue chips stock). LQ45 index consists of 45 stocks selected based on several criteria and therefore, these stocks have high liquidity, market capacity, future prospect and financial condition. In addition, the companies listed in LQ45 index work in various different sectors that represent all companies listed in Indonesian Stock Exchange.

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