Buallay, Hamdan & Zureigat | Corporate Governance and Firm Performance: Evidence from Saudi Arabia

Corporate Governance and Firm

Performance: Evidence from Saudi Arabia
Amina Buallay1, Allam Hamdan2 and Qasim Zureigat3

Abstract
This study aimed to measure the impact of Corporate Governance on Firm performance of listed
companies in Saudi stock exchange. The study methodology was a pooled data collected from
the Saudi stock exchange (TADAUWL) for the period from 2012 to 2014. The study sample is
171 listed companies. The study independent variable is Corporate Governance principals. The
dependent variable is Firm performance which was measured using ROA, ROE and Tobin's Q.
The study also utilized five control variables in order to help measuring the relationship between
Corporate Governance and Firm Performance. In conclusion, the study found that the
governance level was 61.4% in Saudi stock exchange which is considered high compared to
previous studies. The results of the study test indicate that there is no significant impact for
corporate governance adoption on firm's operational and financial performance in the listed
companies in Saudi stock exchange. By testing the Tobin's Q model the study also concluded
that there’s no significant impact for ownership of the largest shareholder and independency of
Board of Directors on firm's market performance. Significant impact was found for the
ownership and the size of the Board of Directors on firm's performance.

JEL Classification: M40, G34

Keywords: Corporate Governance, Firm performance, Agency Theory, Saudi Arabia.

1
Ph.D. Scholar in Accounting; Brunel University, UK. Head of Admin and Finance Services, Ministry of
Education, Bahrain.
2
College of Business & Finance, Ahlia University, Bahrain.
3
Sulaiman AlRajhi School of Business, Sulaiman AlRajhi Colleges, AlQassim, Saudi Arabia.
 Buallay, Hamdan & Zureigat | Corporate Governance and Firm Performance: Evidence from Saudi Arabia

Introduction

Corporate governance is a combination of policies, laws and instructions influencing the way a
firm is managed and controlled, it consists of a framework of rules to grant transparency and
fairness in the relationship between the firms and its shareholders, the framework of corporate
governance consist of both external and internal contracts between employees and the
shareholders it includes distribution of rewards and responsibilities and conditions to avoid
conflicting interests.

OECD in 2001 has published a broader definition of corporate governance written by Iu and
Batten, "Corporate governance refers to the private and public institutions, including laws,
regulations and accepted business practices, which together govern the relationship, in a market
economy, between corporate managers and entrepreneurs (corporate insiders) on one hand, and
those who invest resources in corporations, on the other", which simply indicates that corporate
governance means establish a set of rules and actions that facilitate the shareholders decision
making process. In recent years, the focus on corporate governance has increased due to the
increased in number of bankruptcies caused by fraud or errors in financial accounting, the reason
behind those cases was the absence of corporate governance regulations in the organizations; this
resulted in the implementation of different accounting practices, increased in personal interest
and biased reporting (Ioana, 2014).

Saudi Arabia has witnessed several reforms in governance. This started with special attention
being given to internal control systems. Thus, Saudi standard-setters issued internal control
standards in 2000. Saudi companies are required to design their internal control system based on
these internal control standards, corporate governance codes were also issued in 2006, which
became compulsory for all Saudi listed companies in 2010 (Al-Janadi, et al, 2016). Saudi Arabia
was the second country to adopt corporate governance for the public companies in the Gulf
region after Oman. The main objectives of Saudi’s Corporate Governance Regulations was to
provide a universal guideline of rules, regulation and practice for those companies listed in
TADAWUL as well as for their investors; this was a stage to improve the level of protection for
all investors, specifically for the minority shareholders and to provide legal devices that assist the
investors to practice their rights and to found any injustice practices by the majority
shareholders. The story of corporate governance in Saudi backed to 1965 with the beginning of
The Companies Law. The Companies Law was about rules concerning the establishment of
private and public companies. In 2006, the Saudi stock exchange market was crashed, and its
general index tumbled to 25% as a result of this and other circumstance causing a loss of
shareholders confidence. The Capital Market Authority (CMA) issued rules and regulations to
prevent more crises in the future; it was announced a first code of the corporate governance
regulation in Saudi, all of these rules were voluntary until the beginning of 2009.

In December, 2009, 145 companies were voluntary listed on TADAUWL. In 2010 Corporate
Governance it became compulsory for listed companies in Saudi Stock Market. The role of
Capital Market Authority (CMA) was to operate the stock market, adopted Corporate
Governance Regulations (CGR's) and monitor the adherence to specific provisions that are now
required in all Saudi's listed companies, in line with the principles of Organization for Economic
Co-operation and Development (OECD, 2004).

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The impact of corporate governance is expected to affect the firm's performance which is one of
main issues for the stakeholders as it’ helps them to identify the factors that affect the
performance and to consider those factors as indicators for firm's success or failure. Fallatah and
Dickins (2012) investigates the relationship between corporate governance characteristics and
firm performance in Saudi-listed companies. The results found that corporate governance and
firm performance are unrelated. On other hand Ahmed and Hamdan, (2015), explore the impact
of corporate governance on firm performance in Bahrain listed companies and found that
corporate governance is significantly correlated with firm performance. Another different result
was founded by, Gupta and Sharma (2014) they found that corporate governance has limited
impact on both the firm's share prices and on its performance.

Literature Review and Hypotheses development

Corporate Governance is crucial to build a marketplace trust and attract investors in the
corporation, as well as, corporate governance encourage investors' confidence by ensure the
existence of independent board of directors. Moreover, it helps provide a high level of
confidence degree which is very necessary for the whole market operation, as it considers
adherence to business ethics principles. (Guo & Kumara, 2012).

All Saudi listed companies are required to adopt the corporate governance regulations due to the
importance of corporate governance for effective financial, operational and markets
performance. Therefore, a perfect implementation of corporate governance mechanism reduces
the risk for investors, enhance investment capital and improve business performance (Rezaee,
2009). The impact of corporate governance on firm performance has been discussed widely
around the world, different performance measures were used to explore the effect of corporate
governance on firm performance such as operational based measures, market based measures
and financial based measures. Although, the most popular financial measure was used is the
return on equity (ROE) and the most popular operational measure were used is the return on
Assets (Ahmed & Hamdan, 2015) and Tobin's Q was the most popular market measure used in
the studies (Kiel & Nicholson, 2003). On another hand; A more sophisticated proposition is that
corporate governance has a differential impact on demand for debt and depends on the degree to
which governance mitigates default risk in relation to each type of debt: intermediated versus
non-intermediated. In particular, given the differences in monitoring environment there is an
argument that the expected impact of corporate governance on non-intermediated debt will be
different to the more highly monitored intermediated debt (Aldamen, et al, 2012).

Corporate governance and operational performance

Al-Ghamdi and Rhodes, (2015) study the Family Ownership, Corporate Governance and
Performance in Saudi listed companies on sample of 792 observations for the period from 2006
to 2013. The analysis shows that ownership has no relationship with firm performance by using
ROA measure. While Khamis, et al., (2015) found that there is a significant relationship
between performance and ownership measured by ROA in Bahraini listed companies, the study
sample was 42 companies for 5 years from 2007-2011, the analysis shows that institutional
ownership has a negative relationship on company performance if measured by ROA. However,
it was found that managerial ownership has a positive effect on performance. Another study

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 Buallay, Hamdan & Zureigat | Corporate Governance and Firm Performance: Evidence from Saudi Arabia

adopted by Fallatah and Dickins (2012) to investigates the relationship between corporate
governance characteristics and firm performance in Saudi-listed companies on sample of 292
observations for the period from 2006 to 2009 using the ROA measure. The results found that
corporate governance and firm performance (measured as return on assets) are unrelated. In
contra with Fallatah and Dickins there is study adopted by Ahmed and Hamdan, (2015) to
explore the impact of corporate governance on firm performance in Bahrain listed companies on
sample of 42 companies for the period from 2007 to 2011 using the ROA measure. The results
found that corporate governance is significantly correlated with firm performance. Different
results around the world are found regarding the relationship between CG and performance was
performed.

Onakoya (2014) explores the impact of corporate governance practices on bank performance in
Nigeria. Nine banks were examined in the study for the period from 2006 to 2010. The data were
analyzed by using regression test. It was found that ownership structure and the board size are
positively affected by the return on equity. Whereas, negatively associated with return on assets.
Added to that, there is no effect of board structure on corporate governance practice. Also
Mohammed (2012) explores the effect of corporate governance mechanisms on Nigerian banks
performance. He found that corporate governance is associated significantly with banks
performance. As well as, he found that loan deposit ratios and poor asset quality are negatively
affecting the banks performance. In Sri Lanka Guo and Kga (2012) test the impact of corporate
governance practice on firm performance. It was found that size of board is negatively associated
with the firm value. In Malaysia Fooladi (2011) investigated the effect of corporate governance
on Malaysian firm's performance on sample of thirty firms in 2007 annual reports of those firms.
Results show that corporate governance negatively associated with ROE and ROA.

Another Study in China done by Sami et al, (2011) discussed the link between operating
performance and corporate governance, the results show a positive relation between corporate
governance measures and operational performance. Thus, the first hypothesis can be formed as
follows: “There is no significant impact for corporate governance adoption on firm's operational
performance”.

Corporate governance and financial performance

One of the aims of good corporate governance is to mitigate residual losses (Safari et al, 2015).
The study of Ahmed and Hamdan, (2015) explore the impact of corporate governance on firm
performance in Bahrain listed companies on sample of 42 companies for the period from 2007 to
2011 using the ROE measure. The results found that corporate governance is significantly
correlated with firm performance. Afrifa and Tauringana in 2015 provides evidence of the
different effects of corporate governance on the financial performance of small versus medium
firms. The results show that board size has a significant negative impact on the performance of
both sizes of firm. In line with this study Najjar (2012) study the impact of corporate governance
on the insurance firm’s performance in Bahrain for the period from 2005 to 2010. He found that
firm size, Board size and number of block-holders have significant impact on insurance firm’s
performance by comparing them in relation to the return on equity. Moving to Arab countries Al-
Haddad et al. (2011) study a sample of forty-four Jordanian firms listed in Amman Stock
exchange for the period from 2000 to2007. The main objective of this study was to explore

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whether the corporate governance and performance measures are solving the agency problem in
the Jordanian firms. Also, results show that corporate governance is significantly added a value
to the firm. Going broader around Middle East countries Gupta and Sharma (2014) also try to
determine the effect of corporate governance variables on firm performance in South Korean and
Indian firms. This includes variables such as Board Structure, Board Constitution, Conflict of
interest, Disclosure of information, Independent Directors and other Committees. They found
that corporate governance has limited impact on both the firm's share prices and on its financial
performance. Danoshana and Ravivathani (2013) explore the effect of corporate governance on
corporate performance of twenty-five listed financial corporations in Sri Lanka for the period
from 2008 to 2012. They used Return on equity (ROE) and Return on assets (ROA) as key
variables to realize the business performance. Findings show that the variables are significantly
effect on corporation's performance. Moreover, the size of board of directors and audit
committee has a positive impact on the firm's performance. Mitton (2002) conduct a research to
measure the effect of corporate governance practices on firm performance on 398 listed
companies from different countries such as Philippines, Indonesia, Thailand Malaysia and Korea.
Findings show that there is significant impact of corporate governance on firm performance in
1997-1998 during the East Asian Crisis. The results show that governed firms having greater
outside ownership and greater quality indicators. Moving to Europe countries Rosenberg (2003)
found that effective corporate governance practices are more successful in gain profits, whereas
week corporate governance practices get less financial benefits. Thus, firms having poor
governance practices delivered less value to shareholders. The second hypothesis can be formed
as follows: “There is no significant impact for corporate governance adoption on firm's financial
performance”.

Corporate governance and market performance

Fallatah and Dickins (2012) investigates the relationship between corporate governance
characteristics and firm performance in Saudi-listed companies on sample of 292 observations
for the period from 2006 to 2009 using the Tobin's Q measure. The results found that corporate
governance and firm value (measured as Tobin’s Q and market value of equity) are positively
related. In line with this study Al-Ghamdi, and Rhodes, (2015) study the Family Ownership,
Corporate Governance and Performance in Saudi listed companies on sample of 792
observations for the period from 2006 to 2013. The analysis shows that ownership has a
significant positive relationship if measured by Tobin’s Q. There is a strong relationship between
performance and ownership if performance is measured as by Tobin’s Q. However, Al-Matari, et
al, (2012) study the relationship between internal corporate governance mechanisms and firm
performance as measured by Tobin’s in Saudi Arabia. The findings did not add value to firm
performance in Saudi companies and are not in line with the agency theory. Moving to GCC
countries Khamis, et al, (2015) study the relationship between ownership structure and corporate
performance in Bahraini listed companies on sample of 42 for 5 years from 2007-2011. The
analysis shows that institutional ownership has a negative relationship on company performance
if measured by Tobin’s Q. however it was found that managerial ownership has a positive effect
on performance. To find the fact among those conflicting results Siddiqui (2014) examined the
impact of corporate governance characteristics on firm performance based on twenty-five
previous studies by doing meta-analysis. The study examines the legal organisms, the internal
and external governance structures as well as the accounting performance measures. The result

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of this study found that the external governance is measured by anti-takeover provisions.
Moreover, the results indicate that the value of the firm's performance measured by Tobin’s Q
and finally the study found that the there is significant relationship with firm value. Thus, the
third hypothesis can be formed as follows: “There is no significant impact for corporate
governance adoption on firm's Market performance”.

Research Methodology
Study population sample and resources of data

The Data used in this study was collected from the Saudi stock exchange data base
(TADAWUL) which contains 171 listed companies. Firms used in the sample were selected
according to: Data is available in the period of 2012 to 2014. Firms have not been turned off or
merged with other firms during the research period. Data were obtained from Saudi stock
exchange database; we used in our sample the pooled data which combine both time series data
and cross sectional data in our sample.

None of those 171 listed companies were excluded. The sample contains divers listed companies
from fifteen sectors. Table 1 show the companies included in the sample by sector for the periods
(2012-2014). Table 1 shows that there are 7% of Saudi listed companies from Banks & Financial
Services sector, 8.2% from Petrochemical Industries sector, 8.2% from Cement sector, 8.8%
from Retail sector, 1.2% from Energy & Utilities, 9.4% from Agriculture & Food Industries
sector, 2.3% from Telecommunication & Information Technology, 20.5% from Insurance sector,
4.1% from Multi-investment sector, 8.8% from Industrial Investment sector, 9.9% from Building
& Construction sector, 4.7% from Real Estate Development sector, 2.9% from Transport sector,
1.8% from Media & Publishing sector, 2.3% from Hotel & Tourism sector.
Table (1) Sample Selection
Study Total
Sector
population observations
Agriculture & Food Industries 16 48
Banks & Financial Services 12 36
Building & Construction 17 51
Cement 14 42
Energy & Utilities 2 6
Hotel & Tourism 4 12
Industrial Investment 15 45
Insurance 35 105
Media & Publishing 3 9
Multi-investment 7 21
Petrochemical Industries 14 42
Real Estate Development 8 24
Retail 15 45
Telecommunication & Information Technology 4 12
Transport 5 15
Total (Time series 3 years) 171 513

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Measurement of Variables and Descriptive Statistics

Dependent variables
This study aims at investigating the effects of corporate governance on firm's performance, to do
so the study works to investigate the effects of corporate governance on different types of
performance including financial, operational and market performance. Following Roudaki and
Bhuiyan, (2015) the firm performance is measured using three proxies, ROE, ROA and Tobin’s
Q. Those three performance aspects were used as dependent variables in three different
regression models. The current study used return on equity (ROE) to measure financial
performance, return on assets (ROA) to measure operational performance (Danoshana and
Ravivathani, 2013) and Tobin's Q to measure market performance (Kiel and Nicholson, 2003).

Independent variables

The independent variables (corporate governance) has been measured using the Ownership of the
largest shareholder, Ownership of the three largest shareholders, Size of the board of directors,
Independency of board of directors and Posts of chairman and CEO (Akhtaruddin et al., 2009,
Hamdan and Al-Sartawi, 2013, Barros et al., 2013, Bouaziz, 2014). When considering each
dimension, the first dimension of Governance is the ownership of the largest shareholder, table 2
show that the mean percentage for the first corporate governance dimension (GC1) is around
43.2% shows that the largest shareholder in Saudi companies own more than 20% of a
company's outstanding shares While 56.8% of the observations in Saudi have their shareholders
with ownership of less than 20%. This is because the majority of firms in the Saudi market are
family owned business and some of the shareholders own the majority of the company's shares.
This means that some individual stakeholders have the voting power in the firm which
significantly influences the strategic direction as well as the business operations of the firm. This
indicates that Saudi companies are controlled by certain individuals. The mean percentage for the
second corporate governance dimension (GC2) which is Ownership of the three largest
shareholders of all listed companies is 61.7% shows that the ownership of the largest three
shareholders is less than half of the shares in the observations listed in (TADAUWL) database.
This is good indicator that the companies focus on multiple shareholders control. Added to that,
the high percentage shows a strong monitoring by other shareholders in the firms. The results
show that there is no control by the shareholders holding over 50% of shares which are not
affected the stock exchange and the price of shares. Based on corporate governance regulations
“one of the important corporate governance practices is having the board of directors between
seven to thirteen members” which has been labeled in this study as CG3. The mean percentage
for the third corporate governance dimension (GC3) is around 71.9% while only 28.1% of the
observations had either over 13 or below 7 directors shows that the board size is considered to be
aligned with governance practices to take a strategic decision that leads to efficient use of
company resources. A board of directors between 7-13 members can be reasonable, as more the
number involved, the harder it becomes to take decisions. For the fourth corporate governance
dimension (GC4) which is the independency of the board of directors, the mean percentage is
42.5% of board independency. The fourth dimension suggests that more than 50% of total
directors must be appointed as independent directors. The most important element for effective
board is to have a majority of board outsider's involvement. Having a percentage of 57.5% of
observations with less than 50% independent shareholders abroad which is nearly to half of the

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sample may adversely affects disclosure and transparency and could be a possible reason for
conflict of interest.

The mean percentage for the last corporate governance dimension (GC5) which is the separation
in roles of the CEO and the chairman, the duality takes place when the chairman of the board and
CEO roles are combined, the chairman of the board is responsible for managing the board.
However, the CEO is responsible for day-today management of the firm, including the
enforcement of board decisions. Therefore, firms that have duality may have a powerful
individual who has the ability to make decisions that may not maximize shareholders’ wealth.
(Abbadi et al, 2016; Shanikat and Abbadi, 2011). From table 2 around 100% shows that all listed
Saudi companies separating the roles of chairman and the CEO in their company. The Chairman
holds the most critical decisions and had the power to influence the boards; therefore, the
separation between CEO and chairman can lead to an effective board (Bouaziz, 2014). Khiari,
(2013) argued that merge between CEO and chairman role could lead to conflict of interests and
therefore wrong disclosure. Which make this corporate governance practice an important one,
and all Saudi listed companies are adopting it.

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Table (2) Variables labels, measurement and descriptive:

Normal Distribution Test: testing the normality of data was conducted using Jarque-Bera test. The results illustrate that the variable of Size of board of directors is normally
distributed as the p-value appears to be more than 0.050. On the other hand, the remaining continuous variables are not normally distributed as the p-value appears to be less than
0.050. In order to conquer this problem; the natural logarithm of these variables was taken. Significance at: *10%; **5% and ***1% levels.

Descriptive statistics
Labels Variables Measurements Jarque-Bera
Mean SD
(p-value)
Dependent variables:
ROE Financial Is the ratio of net income divided by shareholder’s 0.084 0.202 30,619***
performance equity
ROA Operational Is the ratio of net income divided by total assets. 0.046 0.096 1,884***
performance
Tobin's Q Market Is the (Market value of equity + Book value of short 1.852 1.582 2,739***
performance term liabilities) ÷ Book value of total assets.
Independent variables (dummy variables)
CG1 Ownership of Ownership of largest shareholder bladed 0 If a 0.432 0.496
largest shareholder shareholder has shares more than 20% and bladed 1
otherwise.
CG2 Ownership of Ownership of largest three shareholders bladed 0 if 0.617 0.487
largest three the shareholders have shares more than 50% and
shareholders bladed 1 otherwise.
CG3 Size of board of Size of board of directors bladed 0 if the board 0.719 0.450
directors members are not between seven and thirteen member
and bladed 1 otherwise.
CG4 Independency of Independency of board of directors bladed 0 if the 0.425 0.495
board of directors boards of director members are not controlled by
greater than 50% independent outside directors and
bladed 1 otherwise.
CG5 Posts of chairman Posts of chairman and CEO bladed 0 if the chairman 1.000 0.000
and CEO is the same of CEO and bladed 1 otherwise.
 Buallay, Hamdan & Zureigat | Corporate Governance and Firm Performance: Evidence from Saudi Arabia

Control variables:
Assets Firm Size The total assets of the company. 22,101 60,11 6,021***
9
Age Firm Age The number of years since the company was 20.783 14.91 25***
established. 5
Big4 Auditing quality The company's external auditor one of the big four 0.662 0.474 71***
audit firms (KPMG, E&Y, PWC, Deloitte)
BSize The Size of board The number of board of director members in the 7.454 1.493 5*
of directors company (Trireksani & Djajadikerta, 2016)
Sector Industrial dummy Dummy variable that equals one for industrial
companies.

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Control variables

Five control variables will be discussed for all estimated models of our research. They are: Firm
Size (total assets) and Firm age, (Ahmed & Hamdan, 2015) Board of directors Size (Guo & Kga,
2012), External Auditor (Yaşar, 2013, Barros et al, 2013) and the Sector. The following Table 2
summarizes the measurement of the dependent, independent and control variables.

Study model
In order to measure the relationship between corporate governance and performance; the study
estimates the following linear regression models.
Perf it = β 0 + β1CG1it + β 2CG 2 it + β 3CG3it + β 4CG 4it + β 5CG 5it
+ β 6 LnAssetsit + β 7 Ageit + β 8 Big 4it + β 9 BSizeit + β10 Sectorit + ε i
Where: Perfιt: is a continuous variable; the dependent variable is the firm performance measured by three models:
ROA is the ratio of net income divided by total assets, for the company (i), in the period (t) and ROEιt: is a
continuous variable; the dependent variable is the ratio of net income divided by shareholders equity, for the
company (i), in the period (t) and Tobin’s Qit: is a continuous variable; the dependent variable is the ratio of current
liabilities plus market value of share capital divided by total assets, for the company (i), in the period (t). β0: is the
constant. β1-10: is the slope of the controls and independent variables. CG1it: is dummy variable, bladed 0 if a
shareholder has shares more than 20% and bladed 1 otherwise, for the company (i), in the period (t). CG2: is dummy
variable, bladed 0 if the shareholders have shares more than 50% and bladed 1 otherwise, for the company (i), in the
period (t). CG3it: is dummy variable, bladed 0 if the board members are not between seven and thirteen member and
bladed 1 otherwise, for the company (i), in the period (t). CG4it: is dummy variable, bladed 0 if the boards of
director members are not controlled by greater than 50% independent outside directors and bladed 1 otherwise, for
the company (i), in the period (t). CG5it: is dummy variable, bladed 0 if the chairman is the same of CEO and bladed
1 otherwise, for the company (i), in the period (t). LnAssetsιt: is a logarithmic variable, the total assets of the
company, for the company (i), in the period (t). Ageιt: is a continuous variable, the number of years since the
company was established, for the company (i), in the period (t). Big4ιt: is a dummy variable, the company's external
auditor one of the big four audit firms, for the company (i), in the period (t). BSizeιt: is a continuous variable, the
number of board of director members in the company, for the company (i), in the period (t). Sctrorιt: is a dummy
variable, the area of the economy in which companies work in the
same field or have related product or service, for the company (i), in the period (t). εit: random error.

Corporate Governance, Size and Performance: A Preliminary Analysis

The corporate governance size was divided into two categories; firms with high corporate
governance and firms with low corporate governance based on the value of the calculated
median of corporate governance index. To identify the significance in the variance between the
means of the two samples t-statistic test and z-statistic tests were used. The same can be said
about firm size where size was divided based on assets. Results are shown in table 3.
The operational performance measure (ROA) was found to be higher with companies with low
corporate governance, in other words, companies with lower implementation of corporate
governance have more return on assets.
 Buallay, Hamdan & Zureigat | Corporate Governance and Firm Performance: Evidence from Saudi Arabia

Table (3) Advanced descriptive analysis:

The t-statistic is based on parametric test Two-Independent Sample t test, and z-statistic is based on non-parametric test Kolmogorov-Smirnov Z. The difference Significance at:
*10%; **5% and ***1% levels.
Corporate governance level Firm size
Performance With: Difference Tests With: Difference Tests
High Low Big Small
CG CG t-statistic z-statistic firms firms t-statistic z-statistic
ROA 3.004 3.177 -0.247 -0.922 0.062 0.001 2.199** 3.627***
(0.805) (0.357) (0.028) (0.000)
ROE 5.098 6.157 -0.796 -0.796 0.117 0.005 3.318*** 4.454***
(0.427) (0.427) (0.001) (0.000)
Tobin's Q 1.800 2.169 -2.264** -2.634*** 1.446 2.383 -6.624*** 8.033***
(0.024) (0.008) (0.000) (0.000)
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For the second performance indicator which is the financial performance (ROE) was also
found to be higher with companies with low implementation of corporate governance,
whereas for the third performance which is the market performance (TQ) tend to be
higher with highly implemented corporate governance companies.
By using the t-statistic and z-statistic, the path analysis was found to be insignificance in
the variance between the means of the two samples for operational (ROA) and financial
(ROE) performance. Whereas, the results found a significance in the variance between
the means of the two samples for Tobin's Q. The Mean for both big firm size as well as
for small firm size is measured to find the significance in the difference between the
means of the two categories, t-statistic (Hamdan et al., 2013) and z-statistic was
performed. The path analysis was found to be significance in the variance between the
means of the two samples for operational (ROA), financial (ROE) and market
performance (TQ).

The Compliance of Corporate Governance in Saudi Stock Exchange

The Capital Market Authority has made some big efforts in order to have a highly vital
financial position for the Kingdom with its’ surrounding region. The hypothesis tested the
compliance level of Corporate Governance in Saudi stock exchange as the Saudi aims to
have a crucial investment and business position in the region. Abiding by the Corporate
Governance law can be considered one of the first steps towards its aim as investors and
financial institutions tend to invest in organizations where Corporate Governance is
strictly implemented (Hamdan and Al-Sartawi, 2013). Failing to implement the Corporate
Governance could lead to some serious consequences to the extent of a financial crisis
(Htay et al., 2013). A good Corporate Governance practice cannot only help with
achieving corporate goals but can also help prevent fraudulent acts.

The One-sample t-test shows that the mean of corporate governance compliance is 64.1%
with a standard deviation of 0.101 which explains a great variance in the companies’
level of compliance with the corporate governance. The p-value is less than 0.050,
therefore it can be concluded that there is acceptable level of compliance with the
corporate governance in the listed companies in Saudi stock exchange. Comparing with
other GCC countries, the study of Hamdan and Al-Sartawi, (2013) and Hamdan, et al.,
(2013) found a percentage of 52% level of corporate governance compliance in Kuwait
financial sector. In Bahrain Bourse, the study of Sanad and Al-Sartawi, (2016) found a
percentage of 66.6%, 73.6%, and 72.2% level of corporate governance compliance in
Bahrain financial sector, Services sector, and Industrial sector respectively.

To justify the results of corporate governance compliance; Saudi Arabia has a newly
established corporate governance culture implemented since 2010. Therefore, to have a
mean of 64.1% is considered to be a good sign compared to a country which only
initiated a Corporate Governance culture merely 5 years ago. Saudi have an acceptable
level of Corporate Governance, it moving on the right track as Saudi have a highly
experienced and educated Board of Directors which are expected to lead to a bright
economy in the near future and therefore experience higher growth and a deep and valued
Corporate Governance culture.

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Empirical Study

Like most empirical corporate finance research, the analysis of the relationship between
corporate governance dimensions and firm performance faces the challenge of
endogeneity, which can arise from unobserved heterogeneity, simultaneity, and reverse
causality. In the context of the governance–performance relationship, the problem of
unobserved heterogeneity arises when one or more latent variables drive the observed
relationship between governance dimensions and firm performance.
To check the validity of the study models and data, several tests were performed like,
normal distribution test, time series stationarity test, autocorrelation and Multicolinearity
and models were checked for not having homoscedasticity. Errors were corrected and
results are believed to be accurate.

To reach precise results about the relation between governance and performance. The
study used firm Fixed-Effect approach FE. Results are shown in table 4 (below).
For the first dimension of corporate governance, we found that all performance measures
are no significant relationship with Ownership of largest shareholder dimension. These
results are in line with (Khamis et al., 2015). Traditional agency theory claims that more
concentrated ownership would enhance the ability of shareholders to monitor
management of the company, preventing it from taking self-serving decisions affecting
the performance of the company negatively. Concentrated ownership creates majority
shareholders and minority shareholders with diverging interests and objectives. In a
market environment where laws protecting minority shareholders are absent or weak, a
situation of majority shareholders controlling the company will be created and the
performance of the company would be affected negatively. Theoretically, it may be said
that an increase in ownership concentration should lead to a reduction in the costs of
separation of ownership and control benefiting company performance eventually.
However, the larger shareholders may benefit from that improvement privately at the
expense of smaller shareholders.

For the Second dimension, we found that all performance measures have negative
relationship with the Ownership of largest three shareholder dimension, this result is
consistent with (Abuserdaneh, at el., 2010). The three largest shareholders in the
organization hold shares with a total sum exceeding 50%, this means that those three are
monopolizing and controlling the organization, thus creates a group of controlling
shareholders that would protect their interests rather than the interests of the company
itself or minority shareholders affecting negatively on the performance of the company.
Moving to third dimension which is the board size, the literature has found no conclusive
evidence of a link between board size and performance (Lama, 2012), we found that all
performance measures have positive relationship with this dimension. Based on those
results, it can be concluded that the size of the board of directors’ principal being between
7-13 members has a positive relationship with firm performance. It is believed that a
smaller board is able to direct and make better decisions and that a larger board size may
lead to less firm performance. Several prior studies document the favorable impact of
outside directors on firm decisions aimed at enhancing shareholder wealth (Alves, 2014)
but in KSA we can found that all performance measures are insignificantly affected by
the independency of board of directors. Overall, the reasons behind insignificant results

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in Saudi might be as follow: Saudi’s listed companies are recently adopted the corporate
governance regulations and the effect of those practices are still not have been appears
and not yet affected the firm’s performance. The adoption of corporate governance
regulations by Saudi’s listed companies couldn’t be in proper or actual way. There are
commercial laws in Saudi which protect the investors and it could be used instead of
corporate governance regulations.

Conclusion and Recommendations

The main objective of the study is to evaluate the level of corporate governance practices
in the listed companies in Saudi stock exchange and to in investigate the impact of
Corporate Governance on firm's performance through the Saudi listed companies. The
study aims to measure the impact of the governance on operational, financial and market
performance in Saudi listed companies.

The study raises the questions about the level of CG adoption and the impact of corporate
governance practices on firm's financial operational, performance and market
performance using a sample of 171 Saudi listed companies. Data was collected from
Saudi stock exchange database "TADAWUL". The data collected was pooled data which
use both cross-sectional data and time series data using the financial information of the
year 2012, 2013 and 2014 we end up with 513 observations. Operational performance
which is return on Assets (ROA), financial performance which is return on Equity (ROE)
and market performance which is Tobin's Q (TQ) is used as dependent variables.
Corporate Governance as the independent variable is measured using dummy variables
with five different principals known as: ownership of shareholders should not exceed
20%; the company's three largest shareholders shouldn't be more than 50%; the size of
the board of directors should be in between 7-13 board members; board of directors
should be controlled by over 50% independent outside directors and finally the duties of
the CEO and the chairman should be separated (Akhtaruddin et al., 2009, Hamdan and
Al-Sartawi, 2013, Barros et al., 2013, Bouaziz, 2014). Several control variables were
used: Firm Size (total assets), Firm age, Board of directors Size, External Auditor and the
Sector.

The descriptive results show that the average index of corporate governance for the
period from 2012 to 2014 is greater than 50% (around 61.4% on average), this means that
more than half of Saudi listed companies adopt corporate governance regulations.
We found that the average largest shareholder ownership in Saud's companies was 43.3%
this percentage shows that the largest shareholder in Saudi firms owned more than 20%
of the firm’s shares. Results also found that 32.7% of listed companies their three largest
shareholders have less than half of firm's shares. Moreover, the average of the size of
board of directors was around 12 members; only 37.2% of those boards were
independent. Finally, all listed companies in Saudi showing separation posts of the CEO
and board chair. Three regression models were estimated in order to measure the impact
of Corporate Governance on firm's performance taking into consideration the control
variables.

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Table (4) Fixed-Effect regression results:

Significance at: *10%; **5% and ***1% levels. t-Critical: at df 512, and confidence level of 99% is 2.326 and level of 95% is
1.645 and level of 90% is 1.282. F-Critical (df for denominator n-β-1 = 513-8-1 = 504) and (df for numerator =β =8 and confidence
level of 99% is 2.510 and confidence level of 95% is 1.940 and confidence level of 10% is 1.67. The independent variable CG5
which is the Duality of chairman and CEO posts was excluded from testing of hypothesis as it was found to be 100% complied.
ROA Model ROE Model Tobin's Q Model
Variable
β t-Statistic β t-Statistic β t-Statistic
Corporate governance dimensions:
Ownership of largest shareholder 0.052 0.863 -0.063 -0.991 0.050 0.864
(0.389) (0.322) (0.388)
Ownership of largest three shareholders -0.067 -1.133 -0.008 -0.133 -0.171 -3.044***
(0.258) (0.894) (0.002)
Size of board of directors 0.137 1.841* 0.078 1.030 0.199 2.792***
(0.066) (0.304) (0.005)
Independency of board of directors 0.077 1.585 0.025 0.521 -0.046 -0.988
(0.114) (0.602) (0.324)
Control variables:
Firm Size -0.094 -1.679* 0.013 0.244 -0.441 -8.258***
(0.094) (0.808) (0.000)
Firm Age 0.225 4.606*** 0.300 6.405*** 0.026 0.562
(0.000) (0.000) (0.574)
Auditing quality 0.268 5.094*** 0.260 5.128*** 0.061 1.209
(0.000) (0.000) (0.227)
Board Size -0.103 -1.315 -0.067 -0.894 -0.171 -2.280**
(0.189) (0.372) (0.023)
R Square 0.134 0.196 0.207
Adjusted R Square 0.116 0.180 0.191
F-Statistic 7.646*** 12.081*** 12.914***
p-value (F-Statistic) (0.000) (0.000) (0.000)

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The ROA model results show that there is no significant impact for corporate governance
adoption on firm's operational performance in the listed companies in Saudi stock
exchange. After testing the effect of control variables on firm's operational performance we
found that negative and insignificant relationship with the firm size, board size and positive
and significant relationship with Big four and firm age. For the sector we found a positive
relationship with all sectors but 5 of those sectors were insignificant.

The ROE model results shows that there is no significant impact for corporate governance
adoption on firm's financial performance in the listed companies in Saudi stock exchange.
After testing the effect of control variables on firm's financial performance we found that
positive and insignificant relationship with the firm size, negative and insignificant
relationship with the firm size board size, positive and significant relationship with Big
four and firm age. For the sector we found a positive relationship with all sectors but 5 of
those sectors were insignificant.

The results of TQ model were significant with Ownership of largest three shareholders
dimension and Size of board of director and insignificant with other dimensions. After
testing the effect of control variables on firm's market performance we found that positive
and insignificant relationship with the firm age, negative and insignificant relationship with
the board size, positive and significant relationship with Big four and negative and
insignificant relationship with firm size. For the sector's type appears to have a positive
relationship with market performance (Tobin's Q) except for three sectors which are Multi-
investment, Industrial Investment and Media & Publishing found to have negative
relationship. Only four of those sectors were insignificant.

The study recommends that Corporate Governance Regulations in Saudi to be strictly

implemented to assure that all listed companies in stock exchange are adopting it; the
capital market authority should conduct a workshop about the importance of corporate
governance for companies listed in Saudi exchange to increase the level of corporate
governance adoption as it's only 61%.
In Saudi, the laws associated with protecting minority shareholders are weak, majority
shareholders controlling the company will be created and the performance of the company
would be affected negatively. Therefore, we recommend the Capital Market Authority to
pay more attention to ownership concentration in the Saudi listed companies to avoid the
controlling of majority shareholders.

Moreover, the Capital Market Authority should have a clear and mandatory law associated
with number boards of directors to limit the number of boards on all listed companies in
Saudi stock exchange. It's believed that a smaller board is able to direct and make better
decisions and that a larger board size may lead to less firm performance.
Added to that, the Capital Market Authority should have a law associated with the number
or percentage of independent board of directors in all Saudi listed companies as it
considered a highly critical aspect to reduce agency costs and hence increase the firm's
performance.

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Moreover, the stakeholders such as investors, shareholders, creditors and debtors are
recommended to increase their knowledge about the term of corporate governance and its
importance in the business to make better investment choices.

Generally, we suggest that organizers like capital market authority, the government
authorities, external auditors and stock exchange organizer to take the corporate
governance into consideration to assure more adoption of corporate governance.

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