School Of Business

University of Jordan

Corporate Governance Does It Matter?

The Impact of Corporate Governance on Working Capital
Management: A case from the Non Financial Firms in
Jordan

Done By :

Eliana Naffaa : 8160416

Ruba Al Zu’bi :

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Abstract

The main goal of working capital management is to achieve an optimal situation between current
assets and liabilities, which reflects the critical role it plays to maintain the firm in a healthy
financial state. Hence, corporate governance practices can affect the efficiency of working capital
through the decisions relating to the liquidity and level of cash.

Having said the above this study sought to investigate the relationship between corporate
governance and the management of working capital for 125 non financial firms listed at Amman
Stock exchange for the periods (2005 - 2010). In addition, we used the size of the board of
directors, and the CEO tenure period as parameters to measure corporate governance practices in
addition to firm size, firm growth rate and firm performance (ROA) that are used as the control
variables.

The findings of this study support the previous studies which highlighted the important role of
both the board size and the CEO tenure period on efficient management of the working capital
taking Jordanian market as our case study.

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1. Introduction

For the last two decades our world has witnessed major changes which formed a modern
corporate world with new challenges. Further, Corporate Governance has become one of the
main dimensions in corporate planning and it acquires a significant importance for
shareholders, investors and regulators who are watching carefully how well an organization
is effectively, efficiently and ethically governed (Ganesan, 2007) . Corporate Governance is
defined as the framework of rules, procedures and processes by which an organization is
controlled and directed, it involves balancing the interests of the company’s management, its
board of directors, shareholders and other stakeholders. When Gil & Bigger (2013) defined
the corporate governance the definition included the effect of good corporate governance on
the economy growth , based on the know – how firms should maximize its residuals
“Wealth Generation” by real operations and wealth distribution to shareholders , in contrast
bad corporate governance is being unable to meet one of these two targets.
According to Fox and Heeler (2006) Managers in firms should apply the same while taking
operational decision in order to meet one or both of these conditions (wealth generation by
Firm’s real operations a distribution of wealth to shareholders) which based on the structure
of incentives and constraints in which they operate in accordance to legal system.
Moreover, Besides the capital structure decisions and capital budgeting decisions, working
capital management is one of the basic decisions in firms since efficient working capital
management enables a firm to react effectively and quickly during unfavorable sudden
changes in the market, such as interest rates and the prices of raw material, thus a
competitive advantage is obtained over rivals in the same industry (Appuhami, 2008).
Working Capital resources are usually used in the operations of the business and it is defined
as the short investment made by the firm which consists of cash, accounts payable, accounts
receivable and inventory (Brigham & Houston 2004). According to (Isshaq et al. 2009) cash
is considered as the most important component of the working capital. But why companies
should keep cash? Kinz’s Theory states that companies should keep enough cash for
financing everyday transactions, for speculations, and precautionary motives. This also,
indicates the importance of keeping adequate levels of cash in firms (Gill & Bigger 2013).

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Hence, Good corporate governance policies can achieve a high cash balance, high volume of
accounts receivables and payables and fast cash conversion cycle. In contrast poor policies
regarding accounts receivables and payables and inventory have a bad impact on cash
conversion cycle (Gill & Bigger 2013).

1.1 Importance of the study

The main objective of the study is to find out the impact of corporate governance different
mechanisms such as board size and CEO tenure on the efficiency of working capital
management.
Working capital management is important in both developed and emerged market , it is in
particular considered highly important for firms operating in emerged market , due to the
fact to finance needed investments firms in emerging markets has less access to long term
financing hence they depend heavily on their own financing , trade credit and short term
loans from the banks (Chittenden et al., 1998; Saccurato, 1994).
In organization the role of CEO tenure , and the size of the should be taken into
consideration while studying the working capital management due to the man rule they play
while formulating the policies to maintain optimal level of working capital furthermore ,
Board of Directors, Chief Executive Officers (CEOs) and other top level management are
responsible of developing strategic guidance regarding working capital components
including accounts payable , accounts receivables and CCC (Gil & Bigger 2013).
Understating the impact of corporate governance on working capital management can help
the decision makers while setting the corporate strategies which guideline the growth and
secure its sustainability.

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2. Literature Review

Corporate Governance plays an important role in managing working capital since CEO and
board members are responsible of formulating policies pertaining working capital
management Dahya and Travlos (2000). A pioneer study on working capital management
was conducted by Nadiri in the year (1969). After his pioneer study, several researchers
have developed new theory by using Nadiri’s model. There are a very few studies that
investigated the impact of corporate governance on working capital management efficiency.
According to (Gill and Shah, 2012) CEO duality, board size, and audit committee are main
factors to achieve an optimal level of working capital in the organization. Kyereboah-
Coleman (2007), describes that small board sizes can be more effective in communication
and decision-making and leads to strong policies, to enhance independence he suggests a
minimum size of three members, to assure effective auditing and monitoring cash accounts,
accounts payable and accounts receivable which can minimize agency problems and agency
cost. Moreover, lack of independent leadership makes it difficult to the board to respond
flexibly if failures happen in top management Jensen (1993).
According to Saad (2010), Reporting and auditing helps in solving the agency problem by
assisting shareholders to monitor and control the resources of a company.
Additionally, inadequate policies may have a negative impact on cash conversion cycle in
contrast CE O and board members may follow a high cash balance policies that do not
maximize shareholder’s wealth which causes agency problems (Gill and Shah, 2012).
Regarding the internal structure of the board and its impact on the efficiency of working
capital (Machuki and Oketch, 2010) indicates that board members should be divided into
sub-committees to help them in deciding the organization’s strategic goals. Moreover,
frequent meetings should be held in order to set agendas and gather information helps in
determine which issues should be given preference, and to make sure that individuals are
doing their job effectively and efficiently.
(Gill & Biger ,2013) conducted a study on the impact of corporate governance on working
capital management efficiency of American manufacturing firms.

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To measure the impact of corporate governance they used CEO tenure, CEO duality, and
audit committee and board size as independent variables in the organization. And they
measured the efficiency of working capital by measuring the accounts receivables, account
payables, CCC, cash conversion and sales growth in addition to the current the study
showed that there is a positive significant impact of corporate governance on a firm’s
working capital management efficiency.

On the other hand, a study by to Kajananthan and Achchuthan (2013) was conducted to
determine the impact of corporate governance practices on working capital management in
Sri Lanka. They used CEO duality, board size and number of committees as well as board
meeting to measure corporate governance. And, they measured working capital management
efficiency by using CCC, current liabilities to total assets and current assets to total assets.
The study indicates that there is no significant relationship between corporate governance
and working capital management efficiency. the board size, board leadership structure and
board committee have no significant impact on working capital management efficiency.
A study by (Gill and Mathur (2011) ) conducted on Canadian companies for the financial
period of (2009-2011) showed that sale growth has a positive impact on cash holding level.
By using a sample size of 83 Iranian companies in Tehran's stock exchange for the period of
2001-2010, Valipor et. al (2012) explored that there was a negative relationship between
sales growth and cash conversion cycle.
Dittmar et al. (2003, p. 111) study results was taken from (11,000) organizations scattered
over 45 countries , they found that in countries where shareholders’ rights are not well
protected corporations attempt to hold up to twice as much cash as corporations in countries
where shareholder’s rights are well protected . They found also that when shareholder’s
rights are poorly protected, factors which affect cash holdings decisions, such as investment
opportunities and asymmetric information, become less important. Moreover, Dittmar et al.
explored that agency problems are important determinants of corporate cash holdings. For
this reason, having strong corporate governance is important.
As a summary, the limited literature review emphasizes that corporate governance affect the
efficiency of working capital management.

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Theoretical Background:

It is a challenging mission for any firm to maintain good levels of liquidity and profitability
that is working capital management is mainly involved in manage current assets and current
liabilities , since high level of working capital means low risk and less return , while a low
little of working capital means higher risk and higher return. It is worth to mention that well
known theories in finance i.e. Pecking order theory, Tradeoff theory, and free cash flow are
used to explain the different patterns of cash holdings in firms .
According to (Afza and Adnan, 2007) firms set their optimal level of cash holdings by
weighting the marginal costs and marginal benefits of holding cash, benefits of cash holding
are reduction in the likelihood of financial distress; allowing the pursuance of investment
policy when financial constraints are met; and minimization of the costs of raising external
funds or liquidating existing assets (Ferreira and Vilela, 2004). According to ( Afza and
Adnan, 2007) , it is important to keep an adequate level of liquidity within the organization
for smooth operations of a firm. The level of cash a firm maintains is translated by the
policies pertaining working capital requirements.

3.2 Model Development

3.2.1 Sample used

The purpose of this study is to explore the impact of some characteristics of corporate
governance such as CEO tenure and the size of the board of directors on the efficiency of
working capital; the research population is the Non financial firms listed at Amman stock
exchange. Data were gathered from 125 Non financial Firms splitted into 90 Industrial and
35 services for the period from (2005 – 2015).

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3.2.1 Dependant variable

As stated in the study conducted by (Manoori & Muhammad, 2012) most of the studies
used cash conversion cycle (CCC) as a proxy to measure the efficiency of working capital
management. CCC defines the period of time which a firm needs to change its cash into
goods and its goods to cash. Hence, shorter length of CCC means less time a capital is tied
up and the more efficiency in managing working capital (Banomyong, 2005). In contrast the
longer the cash conversion cycle the higher the opportunity cost and the less efficiency in
working capital management.

3.2.2 Independent Variables

a) Board size

Several studies discussed the impact of the board size on the efficiency of working capital
management , in a study by (Jamalinesari & Soheili, 2015) a sample was selected from 115
companies listed in Tehran’s Stock Exchange for the period (2006-2011) showed a
significant and negative relationship between the size of the board of directors and cash
conversion cycle; that is in companies where the members of the board are low cash
conversion cycle is found to be shorter than companies with larger number of board. Their
findings supported the previous results found by (Gill & Mathur, 2011) ,
(Gill & Shah , 2012) and (Gill Biger (2013). Their studies emphasized that small boards of
directors are more effective in making decisions than bigger boards of directors.

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b) CEO Tenure Duration

Defined as the number of years serving as a CEO , the CEO will get the opportunity to
witness the results of his decisions as a matter of fact to secure his job position he will take
decisions which will be serving the interests of shareholders . Hence longer tenure is
expected to have a positive impact on working capital management this argument by
(Kyereboah-Coleman ,2007), and was supported in the results of the study of (Gill and
Biger 2013) which study the impact of corporate governance on working capital
management efficiency of American manufacturing firms’ the sample of the study was
taken from 180 companies in America for the time frame ( 2009 – 2011). Moreover,
(Kamau & Basweti, 2013) findings indicated a weak positive relationship between CEO
tenure and the efficiency of working capital management

c) Firm Size

Natural logarithm of total assets is used as a proxy for firm size. The study of (Gill and
Biger , 2013) Results indicated that there is a negative and significant relationship between
the company's size , and cash conversion cycle. Due to the fact that comparing to smaller
firms, large firms have easier access to capital markets and are more capable to extend trade
credits which enable them to have more investment in working capital (Niskanen &
Niskanen, 2006; Petersen & Rajan, 1997).

d) Growth Opportunity

Previous studies used the ratio of sales growth as a proxy for firm growth, (Valipour et al.
2012) in his study of 83 firms listed in Tahran Stock Exchange for the period from ( 2001 -
2010 ) found a negative relationship between sales growth and cash conversion cycle.

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e) Firm Profitability ( Performance)

The efficiency of WC management would affect positively firm’s value in their study
(Manoori & Muhammad, 2012) about the determinants of working capital management in
firms at Singapore, the results showed a positive relationship between cash conversion
cycle and ROA which means that firms with better profitability have longer cash conversion
cycle. And these results emphasize the findings of (Niskanen & Niskanen, 2006; Petersen &
Rajan, 1997) that Firms with more profitability are more able to expand trade credit to their
customers and this leads to a longer accounts payable period and a positive effect on
profitability.

3.2 Model specification

This study applied fixed and random effect techniques to investigate the appropriate
estimation of Pooled OLS for the variables.
Thus the equation stated the relationship between the variables as per the below format.
CCC= α₀ + α₁CEOTN + α₂ Bsize + α₃ Ln (TA) + α ₄∆Sales+ α₅ ROA + €i

Where:
CEO Tenure (CEOTN): Number of years serving as a CEO
Board Size (Bsize): Number of directors serving on board
Firm Size Ln(TA): Natural logarithm of total assets used as a proxy for firm size.
Sales Growth : (Current year sales 2 - previous year sales)/previous year sales
Return on assets (ROA): Is the proxy to measure the firm profitability (performance)

Hypothesis of the study:

H1: There is a significant positive relationship between CEO Tenure and CCC.
H2: There is a significant negative relationship between Board Size and CCC.
H3: There is a significant negative relationship between firm Growth and CCC.
H4: There is a significant negative relationship between Firm Size and CCC.
H5: There is a significant positive relationship between Firm Performance and CCC.

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3. Results

Table (Ⅰ): Descriptive analysis

Minimum Maximum Mean Std. Dev.
CEO Tenure Duration 2 20 8.654 3.594
Board Size 5 15 8.000 0.957
Firm Size 6.194 12.297 9.164 1.067
Growth -0.256 0.561 0.105 0.138
Performance ( ROA) -0.759 1.450 0.010 0.205

Table (Ⅰ) provides the descriptive statistics of the independent variables in our model; it
shows the mean and the standard deviation for each variable in addition to the minimum and
maximum values.
The average duration of CEO tenure is 8.654 years with a minimum of 2 years and 20 years
maximum of 20 years. The average size of the board of directors is 8 members the
maximum members number is 15 and the minimum is 5.
The growth value range is between -0.256 and 0.561 with an average of 0.105 indicating
that during the taken period some Firms witnessed a drop in sales.
ROA which indicates who well an organization is managing its assets to generate return the
minus results indicates that in the Jordanian markets firms are relying on their own capital to
do investments while generating low return.

Table (Ⅱ): Correlation Matrix

Variables CCC CEO Board Size Growth Firm Size Performance

CCC 1
CEO Tenure 0.485 1
Board Size 0.580 -0.158 1
Growth -0.447 0.385 0.695 1
Firm Size 0.585 0.675 0.405 0.685 1
ROA 0.254 0.285 -0.350 -0.250 0.380 1

The correlation matrix is an indicator of the relationship of the variables with each others.
The value which is near to 1 indicates a positive strong relationship with the corresponding

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variable, whereas the value near to -1 indicates a negative strong relationship with the
relevant variables. CEO Tenure value shown in the table is 0.485, which indicates that it has
a positive relation with CCC. Results also show values of Board size and firm size of 0.580
and 0.585 respectively which shows a positive relation with CCC. On the other hand, there
is a negative relation between firm growth and CCC, i.e. when the rate of growth increase
CCC decrease.
However Growth rate has positive relation with liquidity with a value of 0.171.

Table (Ⅲ): The panel data analysis findings of Fixed Effect Results

Constant 3.450 *

CEO Tenure 0.510 ***

Board Size 0.285 **

Growth -0.195 *

Firm Size 0.750 ***

ROA 0.895 **

Adjusted R Square 0.280

F Statistic 30.980 ***

Hausman Fixed 103.850**

Note: *, **, *** show the statistical significance levels at 0.01, 0.05 and 0.1 respectively

1. CEO Tenure and CCC.

There is a significant positive relationship between CEO tenure and CCC at 0.01, thus we
accept H1.

2. Board Size and CCC

There is a significant positive relationship between Board size and CCC at 0.05, thus we
reject H1.

3. Growth rate and CCC

There is a significant negative relationship between the growth rate and CCC at 0.01, thus
we accept H1.

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4. Firm size and CCC
There is a significant positive relationship between the growth rate of the firms and CCC at
0.10, thus we reject H1.

5. ROA and CCC

There is a significant positive relationship between the firms’ performance and CCC at 0.10,
thus we accept H1.
CEO tenure, Board size , Sales Growth , Firm size and ROA explain only 28% variance in
cash conversion cycle efficiency management in Jordanian firms.

4. Conclusion

We examined the impact of two components of corporate governance; on the management

working capital efficiency which is measured by the CCC.
Regarding the first component we found that CEO Tenure is positively related to CCC
which is consistent with previous studies by (Gill and Mathur , 2011), (Gill and Shah ,2012)
and (Gill & Biger, 2013).
In contrast this study revealed a positive relationship between board size and CCC , which is
not supported by (Gill & Biger, 2013) since the study indicated that small board size should
be more in favor for effective working capital management . Also, among control variables,
this study revealed a positive and significant relationship between the company's size and
CCC on the other hand the previous studies (Manoori & Muhammad, 2012) findings
indicate a negative relationship between firm’s size and CCC. Furthermore, we found
negative significant relationship between the sales growth in a firm and CCC which support
the results of (Valipour et al. 2012) study, which referred to a positive and significant
relationship between the growth opportunities and working capital management. And it also
supports the findings of Gill and Shah (2013) and with (Jamalinesari & Soheili, 2015) who
indicated in their study that, working capital management is conducted more effectively in
companies obtaining high growth opportunities.

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