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The UK Code of Corpoate Governance Link between Compliance and Firm Performance

Author

Listed:
  • Dr. Carol Padgett

    () (ICMA Centre, University of Reading)

  • Amama Shabbir

    () (ICMA Centre, University of Reading)

Abstract

Listed companies in the UK are required to comply or give reasons for non-compliance with the recommendations of the UK code of corporate governance called ‘The Combined Code’. Prior studies investigating the relationship between compliance and firm performance have found the link to be either non-existent or at best weak. This study, taking a more holistic view of compliance develops an index of non-compliance for a panel of FTSE 350 companies for four years (2000 -2003 inclusive). Using total shareholder return (TSR) i.e. the sum of capital gain and dividend yield, as the main measure of firm performance, we find that the Index is inversely related to the TSR, implying that more compliant firms enjoy higher TSR in our sample of companies. Contrary to the widely held assumption in the literature that governance variables are generally endogenous, our direct test for the endogeneity of the Index, finds no evidence of endogeneity. This implies that the causality most likely runs from the Index to performance, rather than the other way round. One reason for the clear contrast of our findings with previous work could be our choice of performance measure. Assuming that compliance with the Code is essentially a means of signalling to the investors that firms are well governed and by implication working in the interest of the shareholders, the effects of such positive perception can be argued to fall more on market driven measures of firm performance than on measures which rely more on accounting based values, such as the various proxies for Tobin’s Q. Another reason could be the emphasis on constructing a finely tuned, comprehensive Index, incorporating elements of compliance with both the letter as well as the spirit of the Code. Overall, our results suggest that for today’s informed and discerning investors, compliance matters not just as a box ticking exercise but as a real change in the governance of large listed companies, for which they are willing to pay a premium.

Suggested Citation

  • Dr. Carol Padgett & Amama Shabbir, 2005. "The UK Code of Corpoate Governance Link between Compliance and Firm Performance," ICMA Centre Discussion Papers in Finance icma-dp2005-17, Henley Business School, Reading University.
  • Handle: RePEc:rdg:icmadp:icma-dp2005-17
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2005-17.pdf
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    Cited by:

    1. Akbar, Saeed & Poletti-Hughes, Jannine & El-Faitouri, Ramadan & Shah, Syed Zulfiqar Ali, 2016. "More on the relationship between corporate governance and firm performance in the UK: Evidence from the application of generalized method of moments estimation," Research in International Business and Finance, Elsevier, vol. 38(C), pages 417-429.

    More about this item

    Keywords

    The Combined Code; corporate governance; compliance index and firm perfornace;

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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