Coc volume_11_issue_2_winter_2014_continued1_

Corporate Ownership & Control / Volume 11, Issue 2, 2014, Continued - 1
155
CORPORATE
OWNERSHIP & CONTROL
Postal Address:
Postal Box 36
Sumy 40014
Ukraine
Tel: +380-542-611025
Fax: +380-542-611025
e-mail: alex_kostyuk@mail.ru
alex_kostyuk@virtusinterpress.org
www.virtusinterpress.org
Journal Corporate Ownership & Control is published
four times a year, in September-November,
December-February, March-May and June-August,
by Publishing House “Virtus Interpress”, Kirova Str.
146/1, office 20, Sumy, 40021, Ukraine.
Information for subscribers: New orders requests
should be addressed to the Editor by e-mail. See the
section "Subscription details".
Back issues: Single issues are available from the
Editor. Details, including prices, are available upon
request.
Advertising: For details, please, contact the Editor of
the journal.
Copyright: All rights reserved. No part of this
publication may be reproduced, stored or transmitted
in any form or by any means without the prior
permission in writing of the Publisher.
Corporate Ownership & Control
ISSN 1727-9232 (printed version)
1810-0368 (CD version)
1810-3057 (online version)
Certificate № 7881
Virtus Interpress. All rights reserved.
КОРПОРАТИВНАЯ
СОБСТВЕННОСТЬ И КОНТРОЛЬ
Почтовый адрес редакции:
Почтовый ящик 36
г. Сумы, 40014
Украина
Тел.: 38-542-611025
Факс: 38-542-611025
эл. почта: alex_kostyuk@mail.ru
alex_kostyuk@virtusinterpress.org
www.virtusinterpress.org
Журнал "Корпоративная собственность и
контроль" издается четыре раза в год в сентябре,
декабре, марте, июне издательским домом Виртус
Интерпресс, ул. Кирова 146/1, г. Сумы, 40021,
Украина.
Информация для подписчиков: заказ на подписку
следует адресовать Редактору журнала по
электронной почте.
Отдельные номера: заказ на приобретение
отдельных номеров следует направлять Редактору
журнала.
Размещение рекламы: за информацией
обращайтесь к Редактору.
Права на копирование и распространение:
копирование, хранение и распространение
материалов журнала в любой форме возможно
лишь с письменного разрешения Издательства.
Корпоративная собственность и контроль
ISSN 1727-9232 (печатная версия)
1810-0368 (версия на компакт-диске)
1810-3057 (электронная версия)
Свидетельство КВ 7881 от 11.09.2003 г.
Виртус Интерпресс. Права защищены.

156
CORPORATE OWNERSHIP & CONTROL
Volume 11, Issue 2, 2014, Continued - 1
CONTENTS
DOES ANALYST FOLLOWING IMPROVE FIRM PERFORMANCE? EVIDENCE FROM
THE MENA REGION 157
Omar Farooq, Harit Satt
ENHANCING THE CORPORATE PERFORMANCE THROUGH SYSTEM DYNAMICS
MODELLING 167
Mridula Sahay, Kuldeep Kumar
THE EFFECT OF CORPORATE GOVERNANCE ON BANK FINANCIAL PERFORMANCE:
EVIDENCE FROM THE ARABIAN PENINSULA 178
Mohamed A. Basuony, Ehab K. A. Mohamed, Ahmed M Al-Baidhani
DEBT, GOVERNANCE AND THE VALUE OF A FIRM 192
K. Rashid, S. M. N. Islam, S. Nuryanah
LINK BETWEEN MARKET RETURN, GOVERNANCE AND EARNINGS MANAGEMENT:
AN EMERGING MARKET PERSPECTIVE 203
Omar Al Farooque, Eko Suyono, Uke Rosita
THE LIFECYCLE OF THE FIRM, CORPORATE GOVERNANCE AND INVESTMENT
PERFORMANCE 224
Jimmy A. Saravia
EXECUTIVE COMPENSATION, ORGANIZATIONAL CULTURE AND THE GLASS
CEILING 239
Michael Dewally, Susan Flaherty, Daniel D. Singer

157
DOES ANALYST FOLLOWING IMPROVE FIRM
PERFORMANCE? EVIDENCE FROM THE MENA REGION
Omar Farooq*, Harit Satt**
Abstract
Given ineffective disclosure and governance mechanisms, are there any mechanisms that can help
improve performance of firms in the MENA region? This paper aims to answer the above question by
documenting the effect of analyst following on firm performance during the period between 2005 and
2009. Our results show that the extent of analyst following does positively affect firm performance.
However, this beneficial impact exists only at high level of analyst following. At lower levels of analysts
following, our results show negative relationship between the two. We argue that high levels of analyst
following, it becomes hard for insiders to evade effective disclosure of firm value. It, therefore, leads to
lower agency problems and, eventually, to better performance. We also show that high levels of analyst
following, partly, improve the informativeness of reported earnings. However, it does not improve the
informativeness to an extent that the information contained in reported earnings is positively reflected
in stock prices.
JEL classification: G32
Keywords: Analyst Following, Corporate Governance, Firm Performance, Earnings Informativeness,
Emerging Markets
* Department of Management, American University in Cairo, Cairo, Egypt
Tel.: 20 102 376 0037
Email: omar.farooq.awan@gmail.com
** School of Business Administration, Al Akhawayn University in Ifrane, Ifrane, Morocco
1. Introduction
Information is the key to efficient functioning of the
stock markets. Securities get priced correctly when
the relevant information about firms get incorporated
into the prices. Financial analysts play an important
role in this process by bringing out new information
about firms. Under normal circumstances, stock
market participants view analysts’ research reports,
forecasts, and recommendations as relatively accurate
sources of information and use them in their
investment decisions. Jensen and Meckling (1976)
suggest that, as information intermediaries, financial
analysts are able to mitigate the agency problems
present within firms. Merton (1987) argues that the
market value of a firm is an increasing function of the
breadth of investor awareness. Conventional wisdom
suggests that one of the ways to increase awareness of
an investor regarding a certain firm is by increasing
the extent of analyst following. Chung and Jo (1996)
argue that the value of a firm is a positive function of
number of analysts following a firm. In addition to
increasing awareness, analyst following may also
effect firm valuation by reducing information
asymmetries and agency problems. Analysts perform
the task of discovering any information that firm
decides to hide. In doing so, they act as a device that
ensures that all information is presented to stock
market participants. As a result, they help reduce
information asymmetries and positively impact firm
valuation. Furthermore, greater the extent of analyst
following, greater is the amount of information that
gets discovered. The extent of analyst following,
therefore, should be an important determinant of the
relationship between analyst following and firm
valuation.
In this paper, we aim to extend the above strand
of literature by documenting whether the extent of
analyst following improves firm performance, an
important proxy for firm valuation, in the previously
unexplored region of the Middle East and North
Africa (MENA). To the best of our knowledge, this is
the first attempt to relate the two in the MENA region.
Given the ability of analysts to uncover new
information, it is intuitive to argue that they are able
to reduce information asymmetries between outsiders
and insiders. Reduction in information asymmetries
makes expropriation technology costly and results in
disciplining the managers by reducing agency
problems. Therefore, analyst following is an obvious
determinant of firm performance. Furthermore,
conventional wisdom suggests that greater is the

158
extent of analyst following for a certain firm, higher is
the reduction in information asymmetries. As a result,
greater is the extent of analyst following, better
should be firm performance. Consistent with our
expectations, our results show that analyst following
does positively affect firm performance in the MENA
region (Morocco, Egypt, Saudi Arabia, United Arab
Emirates, Jordan, Kuwait, and Bahrain) during the
period between 2005 and 2009. However, this
positive impact exists only at high levels of analyst
following. At lower levels of analyst following, we
report a negative impact of analyst following on firm
performance – an unexpected finding. Our results are,
partly, consistent with prior literature that considers
any mechanism that helps resolve information
asymmetries between insiders and outsiders as value
relevant for stock market participants. As an example,
consider Lang et al. (2004) who document a positive
valuation effect of analyst following in emerging
markets. They argue that emerging markets have
scarcity of information, thereby enhancing the value
relevance of any mechanism that provides valuable
information to investors. Our results are partly
consistent because at the lower levels of analyst
following, our results show that the extent of analyst
following negatively impacts firm performance. This
is surprising because, at most, low analyst following
should result in no impact on firm performance.
Negative association between the two is counter
intuitive.
Another surprising finding of our analysis is the
negative relationship between firm performance and
earnings per share. This relationship is also robust
across different sub-samples. One reason for this
negative impact is the low information content of
reported earnings. Investors, aware of the fact that
firms in the emerging markets misreport information,
have little faith on reported information. Therefore,
they discount earnings per share. In order to see
whether the extent of analyst following improves the
infomativeness of reported earnings, this paper also
documents the impact of analyst following on the
informativeness of reported earnings. Our results
show that analyst following does improve the
informativeness of reported earnings, but it does not
completely offset the lower faith that investors have
on reported information. Our results show that the
magnitude of negative relationship between earnings
per share and firm performance reduce significantly
as the extent of analyst following goes up.
Our results are important for investors investing
in the MENA region. One of the main problems faced
by these investors is that it is almost impossible for
them to differentiate between good and bad firms.
However, our results show that investors can use
analyst following to infer which firm is expected to do
good and which firm is expected to do bad.
Furthermore, our results also indicate that analyst
following can also be used to improve the
informativeness of reported earnings. Our results
show that investors can complement accounting
information with analyst following to distinguish
between true and manipulated accounting
information. It is important to mention here that our
paper adds to the debate on the effectiveness of
alternate/external governance mechanisms in the
MENA region. Unlike the developed markets,
analysts are not considered very important monitoring
mechanisms in the MENA region. Farooq and Id Ali
(2012) show no value in analysts’ recommendation in
the MENA region. They consider lower demand for
analyst services and relatively low market for
reputation in the MENA region for their result.
However, our results indicate that analysts do have
some value for stock market participants. The
increased scrutiny provided by them helps in reducing
information asymmetries, thereby improving firm
performance.
The remainder of the paper is structured as
follows: Section 2 briefly discusses motivation and
background for this study. Section 3 summarizes the
data and Section 4 presents assessment of our
hypothesis. Section 5 discusses implications of our
findings and the paper concludes with Section 6.
2. Motivation and background
Prior literature characterizes emerging markets with
ineffective and weak corporate governance
mechanisms. Claessens and Fan (2003), for instance,
note that traditional governance mechanisms are weak
in emerging markets. In another related study, Farooq
and Kacemi (2011) document that an average firm in
the Middle East and North Africa is owned and
controlled by a single entity. They argue that
concentration of ownership in the hands of a few
gives rise to many of the agency problems. These and
numerous other studies argue that weak enforcement
of investor protection laws, presence of family
control, and lax implementation of anti-director rights
contribute to ineffectiveness of corporate governance
mechanisms in emerging markets. Prior literature
suggests that ineffective governance mechanisms
result in poor information disclosure. Leuz et al.
(2003), for instance, document that managers and
insiders do not disclose true information about their
firms in emerging markets. As a result, agency
problems are exacerbated, thereby causing adverse
impact on firm performance. Dowell et al. (2000)
argue that firms with no or little adaptation to global
governance standards have lesser market value. In
another related study, Black (2001) shows that
ineffective corporate governance mechanisms
adversely affect firm valuations in emerging markets.
This strand of literature argues that higher information
asymmetries in poorly governed firms provide
incentives to managers/controlling shareholders to
expropriate resources, thereby negatively affecting
firm performance.

159
Given that financial analysts can help resolve
some of the inefficiencies in corporate governance
mechanisms, this paper argues that analyst following
is a value enhancing mechanism in emerging markets.
Analysts resolve inefficiencies in governance
mechanisms by bringing out new information to stock
market participants. Michaely and Womack (1999)
note that analysts are the agents that collect, interpret,
and disseminate public and private information to
stock market participants. By disseminating valuable
information, analysts are able to resolve information
asymmetries. Amir et al. (1999) also suggest that
analysts’ research mitigate information deficiencies
present in financial statements. This paper argues that
analysts’ role as information providers is of
paramount importance in emerging markets
(Claessens et al., 2002; Lins, 2003; Dyck and
Zingales, 2004; Nenova, 2003). Nenova (2003) argues
that investors discount firms with high information
asymmetries. Information asymmetries introduce
agency problems within firms and expose investors to
excessive risk. Therefore, any mechanism that can
help in reducing information asymmetries is of great
importance to stock market participants.
Our arguments are consistent with prior
literature that considers financial analysts to substitute
for corporate governance mechanisms in emerging
markets. Lang et al. (2004), for example, document
the substitution effect of analysts by showing that the
extent of analyst following mitigates the negative
effect of lower investor protection on valuation in
emerging markets. In another related study, Knyazeva
(2007) documents that analyst following improves
firm performance by substituting for corporate
governance. Main argument in this strand of literature
is that analysts’ role as information providers allow
investors to offset any information misreported by
firms. This strand of literature also argues that the
nature of analyst’s job is such that he has to make
every effort to bring to light any information
misreported or not disclosed by firms.1
Conventional
wisdom suggests that more is the number of analysts
looking out for information, greater is the chances that
no information remains misreported or undisclosed.
As a result, higher analyst following should affect
firm performance more than lower analyst following.
At a lower level of analyst following, the information
asymmetries are not resolved to an extent that analyst
following becomes valuable for stock market
participants. It, therefore, leads us to hypothesis a
positive but a nonlinear relationship between analyst
following and firm performance.
1
Plentiful of prior literature suggests that the compensation
of analysts depend on their accuracy (Stickel, 1992; Hong
and Kubik, 2003). Therefore, it is intuitive to argue that
analysts strive for gathering as much value relevant
information as possible.
H1a: There is a positive, but nonlinear, relationship
between analyst following and firm performance in
emerging markets
However, a second school of thought contests the
value enhancing impact of analyst following in
emerging markets.2
This school of thought cites
several reasons behind no impact of analyst following
in emerging markets. Most important of them are: (1)
Lower market for reputation, (2) Less demand for
analyst services, and (3) Unscrupulous behavior of
brokerage houses. All of these factors are expected to
affect value enhancing role of analysts to a varying
degree.
 The first issue that arises in emerging
markets is the absence of market for reputation.
Anecdotal evidence suggests that there are no rating
agencies like “Institutional Investor (publisher of All-
American Research Team)” or “The Wall Street
Journal (publisher of Best on the Street)” in most of
the emerging markets. Therefore, there is little
incentive for analysts to improve their rankings or
reputation. In the absence of market for reputation, it
is not entirely clear why analysts would compete for
quality. In addition, evidence also suggests lower
development of financial press or financial media in
these markets. For instance, there are no well-
developed TV channels are that specifically related to
financial news. If there were such TV channels, it
would have been possible for some analysts to
develop reputation of being accurate and it would
have pushed the others to be accurate as well. Lower
market for reputation should lower the pressures that
analysts may face to improve value of their research.
As a result, value enhancing role analysts is expected
to be less pronounced in emerging markets.
 Another issue that often arises in emerging
stock markets is the lower demand for analyst
services. Prior literature suggests limited participation
of local populations in emerging stock markets.
Giannetti and Koskinen (2005), for example,
document that only 3.3% of Indian population invests
in stock market, while this statistics is 1.2% for
Turkey and 2.3% for Sri Lanka. They also show that,
in contrast to emerging markets, 40.4% of Australian
population, 26.0% of the US populations, and 31.0%
of New Zealand population invests in stock markets.
We argue that limited participation of local
populations in stock markets lowers the demand for
analyst services in emerging markets. Lower demand
of analyst services should reduce the incentives for
analysts to improve their research, thereby resulting in
a weaker relationship between analyst following and
firm performance.
2
There is not enough evidence on how valuable analyst
research is in most of the emerging markets. Erdogan et al.
(2011), for instance, document that analysts are not able to
distinguish well performing and poorly performing firms in
Turkey. In another related study, Farooq and Ahmed (2013)
report low value of analyst recommendations in Pakistan.

160
 In addition to the above two factors,
inadequate regulations pertaining to brokerage houses
may also result in lowering the value of analyst
research. Prior literature documents that brokerage
houses collude to manipulate stock prices in emerging
markets. Khwaja and Mian (2006) document that
“when brokers trade on their own behalf, they earn at
least 50 to 90 percentage points higher annual returns
and these abnormal returns are earned at the expense
of outside investors”. In another related study,
Khanna and Sunder (1999) argue that “brokers were
often accused of collaborating with the company
owners to rig share prices in pump and dump
schemes”. Farooq and Ahmed (2013) argue that one
of the channels via which brokerage houses
manipulate prices is by using financial analysts
employed by them. They explain a scenario where a
brokerage house starts accumulating stocks at a lower
price. It gradually pushes the stock price up until it
reaches a level where brokerage houses ask their
analysts to issue buy recommendations. Naive
investors, anticipating stock prices to go up further,
keep on buying in response to analysts’ buy
recommendations. At this high price, brokerage
houses start disposing off their accumulated stocks.
An outcome of such behavior is the decline in value
enhancing role analysts in emerging markets.
All of the above mentioned factors may result in
insignificant relationship between analyst following
and firm performance.
H1b: There is no relationship between analyst
following and firm performance in emerging markets
3. Data
This paper examines how the extent of analyst
following affects firm performance in the MENA
region. We select Morocco, Egypt, Saudi Arabia,
United Arab Emirates, Jordan, Kuwait, and Bahrain
as the representative stock markets for the MENA
region because of their relatively more development.
The sample period is between 2005 and 2009. The
following sub-sections will explain the data in greater
detail.
3.1 Analyst following
We define analyst following by the maximum number
of analysts issuing annual earnings forecasts in a
given year. Greater the number of analysts following
a firm, the better is its information environment and
lower is information asymmetry. Data for analyst
following is obtained from the I/B/E/S.3
Table 1
3
The Institutional Brokers' Estimate System (I/B/E/S) is a
database owned by Thomson Financials and provides data
on analyst activities, such as earnings forecasts and stock
recommendations issued by them. The IBES provides a data
entry for each forecast and each recommendation
announcement by each analyst whose brokerage house
contributes to the database. Each observation in the file
documents the descriptive statistics for analyst
following during our sample period. Panel A presents
descriptive statistics for each year, while Panel B and
Panel C presents similar statistics for each country
and each industry respectively. Our results in Table 1,
Panel A, show that analyst following gradually
increased from 0.8497 in 2005 to 2.8732 in 2009. It
shows gradual improvement in analyst industry in the
MENA region. It also shows that maximum analyst
following that a firm generated was 11 analysts in
2005. It also gradually increased to 20 analysts by
2009. Furthermore, Table 1, Panel B, shows that firms
headquartered in United Arab Emirates, Morocco, and
Egypt have the highest level of analyst following in
the region. We report average analyst following of
1.6780 in United Arab Emirates, 1.6238 in Morocco,
and 1.3145 in Egypt. Table 1, Panel B, also reports
that firms headquartered in Kuwait have the least
level of analyst following in the region. The results in
Table 1, Panel C, show that firms belonging to
Telecommunication sector have the highest level of
analyst following. It is intuitive because most of
Telecommunication firms are large and very
profitable firms in the region.
Table 1 documents the descriptive statistics for
analyst following in the MENA region, i.e. Morocco,
Jordan, Bahrain, Egypt, Kuwait, United Arab of
Emirates, Saudi Arabia, and Qatar. The sample period
is from 2005 to 2009. Panel A document descriptive
statistics for each year, while Panel B and Panel C
document similar statistics for each country and each
industry respectively.
3.2 Firm performance
This paper measures firm performance by market-
adjusted returns (RET). We define RET as the
difference between stock returns and market returns.
Stock prices and market index are obtained from the
Datastream. The stock price data and the market index
data was obtained for the first and the last day of a
given year to compute RET.
3.3 Control variables
This paper uses the following firm-specific
characteristics as control variables. The data for
control variables is obtained from the Worldscope.
 SIZE: We measure size by log of market
capitalization. Conventional wisdom suggests that
large firms have lower agency problems due to
increased interest from stock market participants
(investors and analysts). Lower agency problems
should lead to better performance of large firms (Fang
represents the issuance of a forecast or a recommendation
by a particular brokerage house for a specific firm. For
instance, one observation would be a forecast or a
recommendation by Brokerage House ABC regarding Firm
XYZ.

161
et al., 2009). Furthermore, Bhattacharyya and Saxena
(2009) argue that larger firms have more bargaining
power over their suppliers and competitors, thereby
improving their performance.
Table 1. Descriptive statistics for analyst following
Panel A. Analyst following in different years
Years Average Standard Deviation Maximum Minimum
2005 0.2621 0.8497 11 0
2006 0.4681 1.1791 13 0
2007 0.6909 1.4454 13 0
2008 1.0439 2.1206 14 0
2009 1.4015 2.8732 20 0
Panel B. Analyst following in different countries
Countries Average Standard Deviation Maximum Minimum
Bahrain 0.3095 0.6220 3 0
Egypt 1.3145 2.3932 14 0
Jordan 0.3102 0.7532 5 0
Kuwait 0.2415 0.9515 12 0
Morocco 1.6238 1.1392 8 0
Qatar 0.6487 1.8132 13 0
Saudi Arabia 0.6352 1.6066 14 0
United Arab of Emirates 1.6780 3.2715 20 0
Panel C. Analyst following in different industries
Industry Average Standard Deviation Maximum Minimum
Oil and Gas 0.3647 0.9238 5 0
Basic Materials 0.9000 1.5137 10 0
Industrials 0.7870 1.6066 14 0
Consumer Goods 0.4603 0.9242 5 0
Healthcare 0.6000 0.8329 3 0
Consumer Services 0.4240 1.4241 15 0
Telecommunication 4.7600 4.6319 14 0
Utilities 1.6285 1.7836 6 0
Financials 0.7851 1.9637 20 0
Technology 1.1428 2.3904 11 0
 LEVERAGE: We measure leverage by total
debt to total asset ratio. High leverage exposes firms
to greater financial risk. High risk should result in
lower performance (Mitton, 2002).
 EPS: This paper defines EPS as earnings per
share. EPS is an important variable that measures
investor interest in a firm (Chang et al., 2008). It also
measures accounting performance of a firm. Higher
investor interest and superior accounting performance
is expected to translate into better stock price
performance.
 GROWTH: This paper measures GROWTH
by growth in earnings per share. Jegadeesh and Livnat
(2006) document that firms with higher growth have
better stock price performance.
 PoR: It is defined as percentage of earnings
paid as dividends. Prior literature considers dividends
as a tool via which firms can reduce information
asymmetries (Grossman and Hart, 1980; Jensen,
1986; La Porta et al., 2000). Lower information
asymmetries should lead to better stock price
performance.
 VOLATILITY: It is the measure of a stock's
average annual price movement to a high and low
from a mean price for each year. For example, a
stock's price volatility of 20% indicates that the
stock's annual high and low price has shown a
historical variation of +20% to -20% from its annual
average price. We expect firms with high volatility to
exhibit low stock price performance.
Table 2 documents the statistics for our control
variables during our sample period. Panel A
documents the descriptive statistics for control
variables used in our analysis and Panel B documents
the correlation between different control variables. As
is expected, Table 2, Panel A, shows that firms in the
MENA region pay low fraction of their earnings as
dividends. Our results show that the PoR is 30.3736%
for our sample firms. This observation is in contrast to
the PoR in the developed countries where almost 80%
of earnings are distributed to shareholders as
dividends. Table 2, Panel A, also shows that firms in
the MENA region have very low leverage. This
observation is consistent with prior literature that

162
shows that firms in the MENA region rely on their
retained earnings for their long-term financial needs
(Achy, 2009). Furthermore, Table 2, Panel B, shows
low correlation between our control variables, thereby
allowing us to include these variables in regression
analysis.
The following table documents the statistics for
control variables used in regression. The sample
comprise of firms from Morocco, Jordan, Bahrain,
Egypt, Kuwait, United Arab of Emirates, Saudi
Arabia, and Qatar. The period of analysis is from
2005 to 2009. Panel A document descriptive statistics
for control variables, while Panel B document
correlation between different control variables.
Table 2. Statistics for control variables
Panel A. Descriptive statistics
Mean Median Standard Deviation
EPS 3.8409 0.1760 17.8059
SIZE 6.3646 6.3966 2.3453
LEVERAGE 18.7935 13.5730 18.6983
VOLATILITY 30.7110 29.9760 10.8343
PoR 30.3736 21.5045 29.0761
GROWTH 11.8849 7.6535 64.1726
Panel B. Correlation matrix
EPS SIZE LEVERAGE VOLATILITY PoR GROWTH
EPS 1.0000
SIZE 0.2425 1.0000
LEVERAGE 0.0337 -0.0086 1.0000
VOLATILITY -0.1553 0.3339 0.0135 1.0000
PoR 0.1398 0.0512 -0.0708 -0.1815 1.0000
GROWTH -0.0130 -0.0375 0.0062 -0.0827 -0.1560 1.0000
4. Methodology
This paper aims to document the effect of analyst
following on firm performance in the MENA region.
In order to test this hypothesis, we estimate a
regression equation with market-adjusted returns
(RET) as a dependent variable and two variables
representing analyst following (ANALYST) and
square of analyst following (ANALYST*ANALYST)
as independent variables. Furthermore, as mentioned
above, we also include a number of control variables
in our regression equation. These variables are
earnings per share (EPS), log of market capitalization
(SIZE), total debt to total asset ratio (LEVERAGE),
stock price volatility (VOLATILITY), dividend
payout ratio (PoR), growth in earnings per share
(GROWTH), and year dummies (YDUM). Our basic
regression takes the following form. It is important to
mention here that we use panel data regression with
fixed effects for our analysis. Hausman test was used
to decide between fixed effect and random effects.
   
       
      εYDUMβGROWTHβPoRβ
VOLATILITYβLEVERAGEβSIZEβEPSβ
ANALYST*ANALYSTβANALYSTβαRET
Yr
Yr
87
6543
21




(1)
The results of our analysis are reported in Table
3. Our results show that the extent of analysts
following improves firm performance only at high
levels. We report significant and positive coefficient
of ANALYST*ANALYST. At low levels of analyst
following, our results indicate a negative relationship
between analyst following and firm performance. We
report significantly negative coefficient of
ANALYST. Our results indicate that high analyst
following is associated with lower information
asymmetries in the MENA region. Lower information
asymmetries lead to lower agency problems, thereby
positively influencing firm performance. However, at
low level of analyst following, information
asymmetries do not get resolved to an extent that it
influences firm performance positively. Surprisingly,
our results also show that there is a negative
relationship between earnings per share and firm
performance. We report significant and negative
coefficient of EPS. It indicates that stock market
participants do not value the reported earnings on
their face value.
Table 3 documents the effect of analyst
following on firm performance in the MENA region
(Morocco, Egypt, Saudi Arabia, United Arab
Emirates, Jordan, Kuwait, and Bahrain). The period of
analysis is from 2005 to 2009. The panel data
regression with fixed effects is performed using
Equation (1). The coefficients with 1% significance
are followed by ***, coefficient with 5% by **, and
coefficients with 10% by *.

163
Table 3. Effect of analyst following on firm performance
Equation (1)
ANALYST -0.0901***
ANALYST*ANALYST 0.0069***
EPS -0.0150***
SIZE 0.6773***
LEVERAGE 0.0063
VOLATILITY -0.0296**
PoR 0.0022**
GROWTH 0.0026***
Year Dummies Yes
No. of Observations 974
F-Value 47.32
R2
within 0.4022
There may be concerns that the results obtained
above are confined to certain sub-sets of stocks. For
instance, smaller firms have higher information
asymmetries and analysts’ role to reduce these
asymmetries should be more pronounced in these
firms relative to larger firms. As a result, analyst
following should be more value relevant for small
firms. Lang et al. (2004) argue that increased analyst
following is associated with higher valuations,
particularly for firms likely to have higher
information asymmetries. In order to overcome these
concerns, we divide our sample into different groups
– large / small firms, firms with high / low debt, and
firms from common law / civil law countries. All of
these groups are characterized by different levels of
information asymmetries. Large firms, firms with
high debt, and firms from common law countries have
better information environment relative to small
firms, firms with low debt, and firms from civil law
countries, respectively. We re-estimate Equation (1)
for each group. Results of our analysis are reported in
Table 4. We report that our results hold true in both
civil law and common law countries. Interestingly,
our results also show that our results hold in a sub-
sample of large firms and in a sub-sample of firms
with high leverage. We report negative and significant
coefficient of ANALYST and positive and significant
coefficient of ANALYST*ANALYST for these
groups. Both of these groups have lower information
asymmetries. Larger firms enjoy more interests from
investors and analysts, while firms with high debt
command more scrutiny from creditors. As a result,
the incremental value of analysts should be less
pronounced in these sub-samples. We report
insignificant impact of analyst following in sub-
samples characterized by high information
asymmetries – small firms and firms with low debt.
This finding is in contrast with Lang et al. (2004) who
document that analyst following is more value
relevant in asymmetric information environments.
The following table documents the effect of
analyst following on firm performance in different
sub-samples (Large/Small, High Leverage/Low
Leverage, Common Law/Civil Law). The sample
comprise of firms from the MENA region (Morocco,
Egypt, Saudi Arabia, United Arab Emirates, Jordan,
Kuwait, and Bahrain). The period of analysis is from
2005 to 2009. The panel data regression with fixed
effects is performed using Equation (1). The
coefficients with 1% significance are followed by
***, coefficient with 5% by **, and coefficients with
10% by *.
Table 4. Effect of analyst following on firm performance in different sub-samples
Size Leverage Legal Traditions
Large Small High Low
Common
Law
Civil Law
ANALYST -0.0875** -0.0614 -0.1017*** -0.0516 -0.0282 -0.0988**
ANALYST*ANALYST 0.0063** -0.0175 0.0071*** 0.0060 0.0041** 0.0065*
EPS -0.0167*** -0.1194*** -0.0110* -0.0167*** -0.0620*** -0.0066**
SIZE 0.719*** 0.6222*** 0.7515*** 0.7281*** 1.1338*** 0.3967***
LEVERAGE 0.0029 -0.0054** 0.0012 -0.0099 0.01410* 0.0031
VOLATILITY -0.0411** -0.0249** -0.0183 -0.0475** -0.0592*** 0.0038
PoR 0.0041*** -0.0008 0.0018 0.0025* 0.0038** 0.0015
GROWTH 0.0038*** 0.0011*** 0.0031*** 0.0018*** 0.0017** 0.0030***
Year Dummies Yes Yes Yes Yes Yes Yes
No. of Observations 554 420 462 512 320 654
F-Value 41.10 19.61 17.24 37.45 65.80 16.33
R2
within 0.4518 0.3532 0.4208 0.4584 0.7128 0.3117

164
5. Discussion of results
Our results have shown that high level of analyst
following has a positive impact on firm performance.
We argue that at high level of analyst following,
information asymmetries are reduced to a significant
level and therefore cause firm performance to
improve. One implication of our argument is that, at
high level of analyst following, firms should be
unable to manipulate their financial statements. As a
result, we should expect a positive impact of high
analyst following on the informativeness of reported
earnings. In order to test our conjecture, we introduce
two more variables in Equation (1). These variables
represent interaction between analyst following and
earnings per share (ANALYST*EPS) and interaction
between square of analyst following and earnings per
share (ANALYST*ANALYST*EPS). Our modified
equation takes the following form:
   
     
     
      εYDUMβGROWTHβPoRβ
VOLATILITYβLEVERAGEβSIZEβ
EPS*ANALYST*ANALYSTβEPS*ANALYSTβEPSβ
ANALYST*ANALYSTβANALYSTβαRET
Yr
Yr
109
876
543
21





(2)
The results of our analysis are reported in Table
5. Contrary to our expectations, our results report
negative and significant coefficient of
ANALYST*EPS and of
ANALYST*ANALYST*EPS. However, we show
that the magnitude of coefficient of
ANALYST*ANALYST*EPS is significantly less
than coefficient of ANALYST*EPS. It shows that
higher level of analyst following does have, at least,
some beneficial impact on the informativeness of
reported earnings. However, the beneficial impact is
not to an extent that it results in completely restoring
the credibility of reported earnings. Our findings,
partly, support Farooq (2013) who document positive
impact of analyst following on informativeness of
reported earnings in the MENA region.
The following table documents the effect of
analyst following on informativeness of earnings in
the MENA region (Morocco, Egypt, Saudi Arabia,
United Arab Emirates, Jordan, Kuwait, and Bahrain).
The period of analysis is from 2005 to 2009. The
panel data regression with fixed effects is performed
using Equation (2). The coefficients with 1%
significance are followed by ***, coefficient with 5%
by **, and coefficients with 10% by *.
Table 5. Effect of analyst following on informativeness of earnings
Equation (2)
ANALYST -0.1044***
ANALYST*ANALYST 0.0087***
EPS -2.3700***
ANALYST*EPS -0.2419**
ANALYST*ANALYST*EPS -0.0005**
SIZE 0.6756***
LEVERAGE 0.0062
VOLATILITY -0.0300**
PoR 0.0023**
GROWTH 0.0027***
Year Dummies Yes
No. of Observations 974
F-Value 40.01
R2
within 0.4034
6. Conclusion
This paper documents the impact of analyst following
on firm performance in the MENA region during the
period between 2005 and 2009. The results of our
analysis show that higher analyst following, indeed,
leads to better performance. We argue that lower
information asymmetries that arise as a result of high
analyst following reduce agency problems and result
in improving stock price performance of firms. We
also show that our results hold across different sub-
samples characterized by different characteristics. For
instance, we show that our results are qualitatively the
same in the common law as well as the civil law
countries. We also show that our results hold in a sub-
sample of large firms and in a sub-sample of firms
with high leverage. Interestingly, in the sub-samples
where analysts are needed the most – small firms and
firms with low leverage – our results do not hold. We
report insignificant relationship between analyst
following and firm performance in these sub-samples.
These sub-samples are characterized by higher agency
problems and therefore incremental value of analysts
should be higher in these sub-samples. Surprisingly,
we also show that low level of analyst following is
associated with lower stock price performance. It
shows that lower analyst following does not resolve
information asymmetries and agency problems.
Our results also show negative association
between earnings per share and firm performance. It
indicates low informativeness of reported earnings.
Given that higher analyst following lowers

165
information asymmetries, this paper also tests whether
analyst following improves informativeness of
reported earnings or not. Our results show that high
level of analyst following does improve the quality of
reported earnings, but not to a level that it is
positively reflected in stock prices. Our results have
implications for investors, regulators, and policy
makers in a way that we show misleading information
in reported earnings. Our results indicate that earnings
alone do not convey much information to stock
market participants. Only those reported earnings that
are complemented by high analyst coverage may have
some information value.
References
1. Amir, E., Lev, B., and Sougiannis, T., (1999). What
Value Analysts? Working Paper, The Recanati
Graduate School of Management, Tel Aviv.
2. Bhattacharyya, S. and Saxena, A., (2009). Does the
Firm Size Matter? An Empirical Enquiry into the
Performance of Indian Manufacturing Firms. MPRA
Paper No. 13029, Munich Personal RePEc Archive.
3. Black, B., (2001). The Corporate Governance
Behavior and Market Value of Russian Firms.
Emerging Markets Review, 2(2), pp. 89-108.
4. Chang, H-L., Chen, Y-S., Su, C-W., and Chang, Y-W.
(2008). The Relationship between Stock Price and
EPS: Evidence Based on Taiwan Panel Data.
Economics Bulletin, 3(30), pp. 1-12.
5. Chung, K. H. and Jo, H., (1996). The Impact of
Security Analysts’ Monitoring and Marketing
Functions on the Market Value of Firms. Journal of
Financial and Quantitative Analysis, 31(4), pp. 493-
512.
6. Claessens, S. and Fan, J. P. H., (2003). Corporate
Governance in Asia: A Survey. International Review
of Finance, 3(2), pp. 71-103.
7. Claessens, S., Djankov, S., Fan, J. P. H., and Lang, L.
H. P., (2002). Disentangling the Incentive and
Entrenchment Effects of Large Shareholdings, Journal
of Finance, 57(6), pp. 2741-2771.
8. Dowell, G., Hart, S., and Yeung, B., (2000). Do
Corporate Global Environmental Standards Create or
Destroy Market Value? Management Science, 46(8),
pp. 1059-1074.
9. Dyck, A. and Zingales, L., (2004). Private Benefits of
Control: An International Comparison. Journal of
Finance, 59(4), pp. 537-600.
10. Erdogan, O., Palmon, D., and Yesegel, A., (2011).
Performance of Analysts Recommendation in the
Istanbul Stock Exchange. International Review of
Applied Financial Issues and Economics, 3(3), pp.
491-503.
11. Fang, V. W., Noe, T. H., and Tice, S., (2009). Stock
Market Liquidity and Firm Value. Journal of
Financial Economics, 94(1), pp. 150-169.
12. Farooq, O., (2013). Does Analyst Following Improve
Informativeness of Earnings? Evidence from the
MENA Region. Forthcoming, International Journal of
Business Governance and Ethics, 8(2).
13. Farooq, O. and Ahmed, S., (2013). Do Governance
Reforms Increase Performance of Analysts’
Recommendations? Evidence from an Emerging
Market. International Journal of Business Governance
and Ethics, 8(1), pp. 69-92.
14. Farooq, O. and Kacemi, Y., (2011). Ownership
Concentration, Choice of Auditors, and Firm
Performance: Evidence from the MENA Region.
Review of Middle East Economics and Finance, 7(2),
pp. 1-17.
15. Farooq, O. and Id Ali, L., (2012). Should Investors
Follow Analysts’ Recommendations? Evidence from
the MENA Region. Working Paper, American
University in Cairo, Egypt.
16. Giannetti, M. and Koskinen, Y., (2005). Investor
Protection and the Demand for Equity. Research
Paper No. 64/2004, European Corporate Governance
Institute.
17. Grossman, S. and Hart, O., (1980). Disclosure Laws
and Takeover Bids. Journal of Finance, 35(2), pp.
323-334.
18. Hong, H. and Kubik, J. D., (2003). Analyzing the
Analysts: Career Concerns and Biased Earnings
Forecasts. Journal of Finance, 58(1), pp. 313–351.
19. Jegadeesh, N. and Livnat, J., (2006). Revenue
Surprises and Stock Returns. Journal of Accounting
and Economics, 41(1-2), pp. 147-171.
20. Jensen, M. C., (1986). Agency Costs of Free Cash
Flow, Corporate Finance, and Takeovers. American
Economic Review, 76(2), pp. 323-329.
21. Jensen, M. C. and Meckling, W. H., (1976). Theory of
the Firm: Managerial Behavior, Agency Costs and
Ownership Structure. Journal of Financial Economics
3(4), pp. 305-360.
22. Khanna, T. and Sunder, S. (1999). A Tale of Two
Exchanges. Harvard Business School Case Study.
23. Khwaja, A. I. and Mian, A., (2006). Unchecked
Intermediaries: Price Manipulation in an Emerging
Stock Market. Journal of Financial Economics, 78(1),
pp. 203-241.
24. Knyazeva, D. (2007). Corporate Governance, Analyst
Following and Firm Behavior. Working Paper, New
York University.
25. La Porta, R., Lopez-De-Silanes, F., Shleifer, A., and
Vishny, R. W., (2000). Agency Problems and
Dividend Policies around the World. Journal of
Finance, 55(1), pp. 1-33.
26. Lang, M. H., Lins, K. V., and Miller, D. P., (2004).
Concentrated Control, Analyst Following, and
Valuation: Do Analysts Matter Most When Investors
Are Protected Least? Journal of Accounting Research,
42(3), pp. 589-623.
27. Leuz, C., Nanda, D., and Wysocki, P. D., (2003).
Earnings Management and Investor Protection: An
International Comparison. Journal of Financial
Economics, 69(3), pp. 505-527.
28. Lins, K., (2003). Equity Ownership and Firm Value in
Emerging Markets. Journal of Financial and
Quantitative Analysis, 38(1), pp. 159-184.
29. Merton, R., (1987). A Simple Model of Capital
Market Equilibrium with Incomplete Information.
Journal of Finance, 42(3), pp. 483-510.
30. Michaely, R. and Womack, K., (1999). Conflict of
Interest and the Credibility of Underwriter Analyst
Recommendations. Review of Financial Studies,
12(4), pp. 653-686.
31. Mitton, T., (2002). A Cross-firm Analysis of the
Impact of Corporate Governance on the East Asian
Financial Crisis. Journal of Financial Economics,
64(2), pp. 215-244.

166
32. Nenova, T., (2003). The Value of Corporate Voting
Rights and Control: A Cross Country Analysis.
Journal of Financial Economics, 68(3), pp. 325-351.
33. Stickel, S. E., (1992). Reputation and Performance
Among Security Analysts. Journal of Finance, 47(5),
pp. 1811–1836.

167
ENHANCING THE CORPORATE PERFORMANCE THROUGH
SYSTEM DYNAMICS MODELLING
Mridula Sahay*, Kuldeep Kumar**
Abstract
The aim of the current study is to improve the performance of corporate through application of System
Dynamics (SD) methodology. The paper discusses the importance of system dynamics modelling in
enhancing corporate performance and how it shows the dynamic behaviour of the system. For this
purpose a system dynamics model for an Indian Steel company has been prepared. The paper also
covers a brief introduction of the system dynamics modelling, a brief narration of Steel Sector and the
process adopted in modelling. Some of the important corporate performance parameters such as
market share, revenue, employee’s strength, number of shareholders, installed capacity have been
taken to reflect corporate behaviour. The behaviour of these performance parameters over time is used
for both validation of the model as well as for reflecting their future pattern. The paper concludes that
the SD modelling approach has high potential in understanding corporate performance behaviour and
their by gaining insight into the corporate functioning and taking appropriate remedial steps for
improving its performance.
Keywords: Corporate Performance, System Dynamics, Dynamics Behaviour
* Associate Professor, Amrita Business School, Amrita University, India
** Professor, Faculty of Business, Bond University, Australia
1. Introduction
Corporate performance is a very actual output or
result of a corporation as measured against its
intended outputs, which can be reflected in many
ways. Corporate performances build the image of the
corporation in front of shareholders, investors,
funding agencies, competitors; fulfil the goal of the
company etc. It also effects on the image of the board
of the corporation and their governance. It’s related to
revenue, return on investment, overhead and
operational costs. Many companies strive to be the
best in their market and most never succeed. Many of
the ones that do, so only temporarily and subsequently
lose their position through misunderstanding how
they got there and what is needed to stay there. Very
few, as Collins (2001) has stated, are capable to going
from “good to great”.
Corporate performance is viewed from the
perspective of different stakeholders as businesses
respond to contemporary developments and broader
strategic, commercial and social consideration.
Dahya, et. al. (2002), In 1992, the Cadbury
Committee issued the Code of Best Practice which
recommends that boards of U.K. corporations include
at least three outside directors and that the positions of
chairman and CEO be held by different individuals.
The underlying presumption was that these
recommendations would lead to improved board
oversight. They empirically analyse the relationship
between CEO turnover and corporate performance.
CEO turnover increased following issuance of the
Code; the negative relationship between CEO
turnover and performance became stronger following
the Code’s issuance; and the increase in sensitivity of
turnover to performance was concentrated among
firms that adopted the Code.
Richard et al. (2009) states that organizational
performance encompasses three specific areas of firm
outcomes: (a) financial performance (profits, return
on assets, return on investment, etc.); (b) product
market performance (sales, market share, etc.); and (c)
shareholder return (total shareholder return, economic
value added, etc.
Beaver (2000) states that performance appraisal
is a serious business and not some academic fad that
will fade like so much of the indulgent language and
management tools and techniques currently in vogue
at its most fundamental. Performance appraisal is the
principal means for an organization to assess the
effectiveness of its decision making. In doing this,
judgements can be made about the success or failure
of its strategic management in the context of its
organizational paradigm. The notion of corporate
success is a natural derivative of a firm’s
achievements which is in turn a reflection of the
quality of its management decisions in relation of the
quality of its management decisions in relation to
strategic objectives, market and a whole range of
internal and external circumstances. Given the

168
unpredictability of these circumstances, many of the
current methods of measuring corporate performance
effectively, realistically and consistently appear to be
facile and inappropriate and subject to imaginative
financial engineering and plain management abuse.
Based upon the explanation of Majumdar (1997)
whether larger firms are superior in performance to
smaller firms, or vice-versa and whether older firms
are superior in performance to younger firms, or vice-
versa, have generated large amount of theoretical and
empirical research in the economics, management and
sociology disciplines. Cheng (2008) provides
empirical evidence that firms with larger boards have
lower variability of corporate performance. The
results indicate that board size is negatively associated
with the variability of monthly stock returns, annual
accounting return on assets, Tobin's Q, accounting
accruals, extraordinary items, analyst forecast
inaccuracy, and R&D spending, the level of R&D
expenditures, and the frequency of acquisition and
restructuring activities. The results are consistent with
the view that it takes more compromises for a larger
board to reach consensus, and consequently, decisions
of larger boards are less extreme, leading to less
variable corporate performance.
Prasetyantoko and Parmono (2008) disused that
firm size is positively related to firm profitability, but
it is not related to market capitalization and ownership
factors matters on firm performance.
Wheelen & Hunger (2002) pointed that
businesses are tending to rely less on financial
measures (which are based on Accounting Standards)
such as, profit, return on investment, and return on
assets, alone to assess over all corporate performance
Wheelen and Hunger (2002), defined
performance simply as the end result of activity. At
one level, it maybe as simple and mundane as this
definition, although at another level the notion of a
general measure of performance is both intriguing yet
continually disappointing (Bonoma & Clark 1988).
Choosing a performance measure is one of the
most critical challenges facing organizations (Ittner &
Larcker 1998). It is common for corporations to have
numerous performance measures (Neely, Adams &
Kennerley 2002), though financial measures dominate
for Autralian, UK and US executives (Phillips &
Shanak 2002; Clark 1999; Kokkinaki & Ambler
1999).
Irala (2007) states that traditionally periodic
corporate performance is most often measured using
some variant of historical accounting income (eg. Net
Profit, EPS) or some measures based on the
accounting income (eg. ROI/ ROCE). And he also
examines whether Economic Value Added has got a
better predictive power relative to the traditional
accounting measures such as EPS, ROCE, RONW,
FCF, Capital Productivity (Kp) and Labor
Productivity (Lp)
Harols and Belen (2001) investigate the relation
between the ownership structure and the performance
of corporations if ownership is made multi-
dimensional and also is treated as an endogenous
variable.
Qi, Wu, Zhang (2000), investigate whether and
how the corporate performance of listed Chinese
firms is affected by their shareholding structure.
Adams et al (2005) develop and test the hypothesis
that firms whose CEOs have more decision-making
power should experience more variability in
performance. They suggest that the interaction
between executive characteristics and organizational
variables has important consequences for firm
performance
Joy et al (2007) has shown in their research that
women representation on board increase return on
equity (ROE), return on sales (ROS), return on
investment (ROI) corporate performance. Bryan
(2007) state that companies should redesign their
financial-performance metrics for this new age.
Normally companies focus far too much on measuring
returns on invested capital (ROIC) rather than on
measuring the contributions made by their talented
people. Times have changed. Metrics must change as
well.
During the 1990s and beyond, countries around
the world witnessed calls and/or mandates for more
outside directors on publicly traded companies' boards
even though extant studies find no significant
correlation between outside directors and corporate
performance. Dahya et. al (2007) examine the
connection between changes in board composition
and corporate performance in the U.K. over the
interval 1989–1996, a period that surrounds
publication of the Cadbury Report, which calls for at
least three outside directors for publicly traded
corporations. They find that companies that add
directors to conform to this standard exhibit a
significant improvement in operating performance
both in absolute terms and relative to various peer
group benchmarks. They also find a statistically
significant increase in stock prices around
announcements that outside directors were added in
conformance with this recommendation. They do not
endorse mandated board structures, but the evidence
appears to be that such a mandate is associated with
an improvement in performance in U.K. companies.
Norburn, and Birley, (1998) tested the
relationship between the characteristics and
background of U.S. top executives, and measures of
corporate performance. Results were generally
positive: managerial characteristics not only predicted
performance variations within industries—the top
performers having significantly different managerial
profiles than poorly performing companies—but also
that the characteristics of managers within high-
performing companies were similar across the five
industries.
Firth et al. (2006) has examined the
compensation of CEOs in China's listed firms. First,
they discuss what is known about the setting of CEO

169
compensation and then we go on to examine factors
that may help explain variations in the use of
performance related pay. In China, listed firms have a
dominant or controlling shareholder. Firth et al.
(2006) argue that the distinct types of controlling
shareholder have different impacts on the use of
incentive pay. We find that firms that have a State
agency as the major shareholder do not appear to use
performance related pay. In contrast, firms those have
private block holders or SOEs as their major
shareholders relate the CEO's pay to increases in
stockholders' wealth or increases in profitability.
However the pay–performance sensitivities for CEOs
are low and this raises questions about the
effectiveness of firms' incentive systems.
Above discussion shows that corporate
performance as a whole is missing. Most of them
have worked on composition of the committee,
financial aspect of the company etc., but corporate
performance as a whole like operational performance,
financial performance has not been combined
together. The purpose of this paper is to combine both
operational as well as financial performance together
to measures the performance of the company with
using management science tools like system dynamics
(SD).
2. System Dynamics: principles and
concepts
The system dynamics (SD) has been developed as
industrial dynamics approach has at MIT by Prof. J.
W. Forrester in late sixties. It amalgamates ideas
developed in various system theories. It is a branch of
control theory, which deals with socio-economic
systems and also a branch of management science,
which deals with the problems of controllability. It is
a way of studying the behaviour of any systems to
show how policies, decisions, structure and delays are
inter-related to influence growth and stability. It
integrates the separate functional areas of
management – marketing, investment, research,
personnel, production, accounting etc. Each of these
functions is reduced to a common basis by
recognizing that any economic or corporate
(candidates, instructed) activities consists of flows of
money, orders, materials, personnel, and capital
equipment. These five flows are integrated by an
information network. Industrial dynamics recognizes
the critical importance of this information network in
giving the system its own dynamics characteristics.
It combines both qualitative and quantitative
aspects to explore, realize and communicate complex
ideas. The qualitative part entails the creation of
causal relationship, in which variables are mapped in
a cause and effect relationship pattern.
The quantitative aspect involves the
development of a computer model based upon a
“stock and flow diagram, and equations which depict
interrelated variables in the system. Stock variable
(rectangles) represents the state variables and are the
accumulations in the system. Flow variables (valves)
alter the stocks by filling or draining the stocks.
Arrows point the causal relation between two
variables and also reflects the flow of information
within the model structure.
System dynamics models, however, have two
important differences which are major advantages:
1. They allow for far more complex multiple
interrelationships of variables over time, and
outcomes of those relationships are calculated by the
model rather than being done externally and inputted
in advance.
2. They can include the impact of variables
which are not normally subject to quantification. This
is done by arbitrarily assigning a value of 1.00 to a
subjective variable, and allowing it to vary based on
the management group’s expectations of what would
happen under certain conditions.
System thinking and dynamics plays an
important role in understanding the relationship
between strategic choices and its outcomes. Five
decades ago, Jay Forrester, regarded as the father of
SD, started to advocate for the application of systems
and feedback theory to the formulation of
organizational and social policies (Forrester, 1961).
Peter Senge’s The Fifth Discipline (1990) has been an
important source for understanding system thinking
and dynamics to a wide audience. SD importance is
rooted on the decision-makers limitations to fully
understand their environment and business system
realities due to three main conditions: complexity,
uncertainty, and cognition limitations (Folke, 2006).
Rather than try to optimize for a solution, the
decision-maker choose for satisfying explanations.
This is the groundwork of Simon’s “theory of
bounded rationality”, the type of rationality that a
decision-maker draws on when the situation is too
complex relative to their limited rational abilities
(Simon, 1979). He reasons that decision-making in
practice challenge existing assumptions that
“…decision-makers pursuit optimal choices in all
conditions.” For the operational strategist this
discussion implies that he/she will be only somewhat
capable of retaining and manipulating sufficiently
representative information and structural relations
during the process of strategy formulation due to the
steering of intermediaries, which may be particularly
difficult to anticipate and control (Nobs, Minkus, &
Rummert, 2007).
In SD, a system is a way of understanding any
dynamic process and many complex relations in the
organizations. SD creates a representation of the
operations choices and studies their dynamics,
facilitating the understanding of the relation between
the behavior of a system over time and its underlying
structure and decision rules. Better performing
organizations attempted to gain an understanding of
the system structure before they proceeded to develop
strategies and take action. Concisely, SD is based on a

170
structural theory that offers a panorama on operations
strategy issue
Rahdari and et.al (2007) discussed the model the
effects of fluctuations in world steel price on
stockprice of one of Iranian steel producers. They also
offer some policies to mitigate the global fluctuation
effects on stock price of steel-makers in Iran
Sahay (2011) highlighted an application system
dynamics methodology and develop a cause and
effect relationship model for corporate strategy, which
has potential of integrating board parameters/variables
significant in corporate strategy development.
Kumar and Vrat (1989) discussed the application
of system dynamics to simulate the production flow in
a steel plant. The feedback concepts underlying the
model of a production shop were discussed. Models
of various shops were assembled to construct the
entire flow of the steel production system. The
applications of the model in the area of corporate
planning were discussed.
Sahay (1984) stated that system dynamics model
validation is a systematic trial-search process. He
emphasized the use of both qualitative and
quantitative criteria for model validation followed by
sensitivity testing for monitoring information
economically for the purpose of exercising desired
controls in organizational functions to achieve its
goals.
King et al (1983) conceptualized an integrated
general model of business performance that combined
the individual management disciplines of industrial
economics, reenfield theory and business policy
within the framework of a dynamics feedback model.
Measures to assess the position of a company in its
business environment and the process of strategic
choice were discussed.
King et al (1983) conceptualized an integrated
general model of business performance that combined
the individual management disciplines of industrial
economics, organisation theory and business policy
within the framework of a dynamics feedback model.
Measures to assess the position of a company in its
business environment and the process of strategic
choice were discussed.
Brugnoli (1999) states that Trainers can improve
the evaluation-decision process of management
through improving its system thinking capabilities.
Gary et al (2008) have found that there is
opportunity for system dynamics research to develop
explanations for the observed longitudinal patterns of
performance differences among firms. Such work
addresses an important issue for policy makers,
shareholders, and general managers, and would make
enormous contributions to the strategy field.
3. Objectives of the Paper
Objective of this research paper is to prepare an
integrated dynamic model for improving the
performance of Indian steel company both in its
operational performance (installed capacity actual
production, market share, manpower involved etc.) as
well as financial performance (return on investment,
expenditure and revenue etc.). Authors have chosen
system dynamics techniques for developing a model
among the availability of number of management
science tools and techniques due to its effective and
dynamics behavioural pattern.
4. Steel Industry
Steel industry is a booming industry in the whole
world. The increasing demand for it was mainly
generated by the development project that has been
going on along the world, especially the
infrastructural works and real estate projects that has
been on the boom around the developing countries.
Steel industry was till recently dominated by the
United Sates of America but this scenario is changing
with a rapid pace with the Indian steel companies on
an acquisition spree.
Steel Industry has grown tremendously in the last one
and a half decade with a strong financial condition.
The increasing needs of steel by the developing
countries for its infrastructural projects have pushed
the companies in this industry near their operative
capacity.
The main demand creators for Steel industry are
Automobile industry, Construction Industry,
Infrastructure Industry, Oil and Gas Industry, and
Container Industry.
The Steel industry has enough potential to grow
at a much accelerated pace in the coming future due to
the continuity of the developmental projects around
the world. This industry is at present working near its
productive capacity which needs to be increased with
increasing demand.
It is common today to talk about "the iron and
steel industry" as if it were a single entity, but
historically they were separate products. The steel
industry is often considered to be an indicator of
economic progress, because of the critical role played
by steel in infrastructural and overall ("Steel
Industry". Retrieved 2009-07-12.)
The economic boom in China and India has
caused a massive increase in the demand for steel in
recent years. Between 2000 and 2005, world steel
demand increased by 6%. Since 2000, several Indian
and Chinese steel firms have risen to prominence like
Tata Steel (which bought Corus Group in 2007),
Shanghai Baosteel Group Corporation and Shagang
Group. ArcelorMittal is however the world's largest
steel producer.
In 2008, steel began trading as a commodity on
the London Metal Exchange. At the end of 2008, the
steel industry faced a sharp downturn that led to many
cut-backs. (Unchiselled, Louis (2009-01-01). "Steel
Industry, in Slump, Looks to Federal Stimulus". The
New York Times. Retrieved 2012-04-15)

171
Iron and steel are used widely in the construction
of roads, railways, other infrastructure, appliances,
and buildings. Most large modern structures, such as
stadiums and skyscrapers, bridges, and airports, are
supported by a steel skeleton. Even those with a
concrete structure will employ steel for reinforcing. In
addition, it sees widespread use in major appliances
and cars. Despite growth in usage of aluminium, it is
still the main material for car bodies. Steel is used in a
variety of other construction materials, such as bolts,
nails, and screws (Ochshorn, Jonathan (2002-06-11).
"Steel in 20th Century Architecture". Encyclopedia of
Twentieth Century Architecture. Retrieved 2010-04-
26.) Other common applications include shipbuilding,
pipeline transport, mining, offshore construction,
aerospace, white goods (e.g. washing machines),
heavy equipment such as bulldozers, office furniture,
steel wool, tools, and armour in the form of personal
vests or vehicle armour (better known as rolled
homogeneous armour in this role).
Authors have chosen the field of steel sector for
the study because Indian Steel sector has large
contribution in development of economic base and
industrialization in India. The demand of steel is
growing day by day due to its need in rapid
development of infrastructure, Construction
Company, power sector, telecommunication,
railways, etc.
In India both public and private sector
companies are involved in producing steel. Steel
Authority of India (SAIL), Rashtriya Ispat Nigam Ltd.
(RINL), NMDC Ltd., Maganese Ore (India) Ltd.,
MSTC Ltd., Hindustan Steel works Construction Ltd,
MECON Ltd., Bharat Regrafactories Ltd., Sponge
Iron India Ltd., Kundremukh Iron Ore Company Ltd.
are the Indian government undertaking public sector’s
steel plants and Tata Steel Ltd., Essar Steel Ltd., JSW
Steel Ltd., Jindal Steel & Power Ltd., Spat Industries
Ltd. Bhusan Power & Steel Ltd., Monnet Ispat &
Energy Ltd., Sponge Iron Industry, Pig Iron Industry,
Electric Arc Furnace Industry, Induction Furnance
Industry, Hot Rolled Long Products Units, Steel Wire
Drawing Units, Hot Rolled Steel Sheets/Strips/Plates
Units, Cold Rolled Steel Sheets/Strips Units,
Galvanised and Color Coated Sheets/strips Units, Tin
Plate Units are private sectors companies
Steel production in India has increased by a
compounded annual growth rate (CAGR) of 8 percent
over the period 2002-03 to 2006-07. Going forward,
growth in India is projected to be higher than the
world average, as the per capita consumption of steel
in India, at around 46 kg, is well below the world
average (150 kg) and that of developed countries (400
kg). Indian demand is projected to rise to 200 million
tonnes by 2015. Given the strong demand scenario,
most global steel players are into a massive capacity
expansion mode, either through brownfield or
greenfield route. By 2012, the steel production
capacity in India is expected to touch 124 million
tonnes and 275 million tonnes by 2020. While
greenfield projects are slated to add 28.7 million
tonnes, brownfield expansions are estimated to add
40.5 million tonnes to the existing capacity of 55
million tonnes.
5. System Dynamics Modelling for
Corporate Performance of Indian Steel
Company
Improvement in corporate performance in traditional
way primarily made through the decision makers at
various levels such as board of the corporation and the
managers of the works based on comparing and
judging various identifies factors and the corporate
performance empirically; or through factor analysis
combining methods of investigating exceptions and
drawing commonality in the pattern of the outcome
and the behaviour; or using regression analysis/multi-
variant analysis or econometric model.
These approaches provide very broadly the
future course of action without understanding intrinsic
causes. They are piece meal approach and laps
coherence and system thinking and dynamics of the
system. The application of system dynamics
methodology attempts on improvement intervention
based on system thinking and has potential to solve
complex problem. Sector-wise simulated results are
discussed below.
5.1Demand and capacity
Here, demand of product and installed capacity are
considered as a level variable. Demand of product is
31000 MT and installed capacity is 3500 MT/year in
the reference year 2001.
Figure 1 show that demand of product is
increases with demand of product increasing rate and
demand of product increasing rate is calculated by
demand rising fraction multiply by demand of product
and divided by year. Installed capacity is depend on
installation time and additional capacity multiplier.
Market share is an auxiliary variable and it has
calculated by demand of product, sales and demand
fulfilling factor.
We can see in figure 2 that demand of product in
the country and installed capacity increases every
year. It has rise from 31000 MT to 51000 MT
(64.5%) and installed capacity of the company has
increased 3500 MT to 6000 MT (71.4%) in six year.
5.2 Revenue and Expenses
In this sector, manufacturing cost, other expenses,
loans & advances are considered as level variables.
Manufacturing cost changes over the time with the
help of increase in manufacturing cost rate and
manufacturing cost rate is effected and percentage
increase in manufacturing cost per year. Similarly
other expense also changes with other expenses
increasing rate and inflation rate of general

172
commodity per year. loans & advances changes.
Revenue is calculated with sales and price per TMT
and for the calculation of price per TMT, selling price
in ref year, product mix factor and ratio of current
inflation index to normal index have taken.
Board members salary and compensation, salary of
employee, annual manufacturing cost, annual other
expenses, S&A expenses, interest payment have
considered to calculated expenditure.
5.3 Corporate Performance
In this sector, authors have assumed that desired
corporate performance level should be minimum 60 in
the reference year 2001 and for the result of corporate
performance index; they also have calculated total
corporate performance with market share, profit,
installed capacity, employee, shareholders etc. and for
each variables, there is some weigthages point.
5.4 Validated criteria for the developed
model
For validation, very few selected performance
indicators for enhancing the performance of corporate
has taken like employee’s strength, no. of
shareholders, installed capacity, return on investment,
market share, expenditure, revenue etc.
The validation in the system dynamics
modelling means behaviour of the model is resembles
the actual behaviour of the system. This means from
the model, some important variables are chosen and
their simulated behaviour is compared with actual
values for the reference period.
The SD model with the data collected from the
company’s report of the reference year 2001 has been
simulated. The results are observed both in the tabular
and graphical form for important variables from each
sector. By modifying some of the structural
relationships, values of some multipliers and graph
functions and simulated till acceptable model output
is obtained.
Figure 1. Demand and Capacity Stock- flow diagram
MARKET SHARE
DEMAND RISING FRACTION
ACTUAL FUND AVAILABLE
FOR INVESTMENT
DEMAND OF PRODUCT
DEMAND OF PRODUCT
INCREASING RATE
INSTALLED CAPACITY
CAPACITY INCREASING RATE DECREASE IN INSTALLED
PRODUCTION
CAPACITY RATE
ACTUAL
PRODUCTION
DESIRED PRODUCTION
CAPACITY
UTILIZATION
ANTICIPATED MARKET SHARE
SALES
INCREASE IN INSTALLED
CAPACITY DESIRED
AVERAGE CAPACITY UTILIZATION
RETAINED EARNING FOR
INVESTMENT
YEAR
SALES
INCREASE IN INSTALLED
CAPACITY DESIRED
INSTALLATION TIME
INSTALLATION COSTPER TMT
RE USE FRACTION
DEMAND FULFILLING FACTOR
INVESTMENT NEED TO INSTALLE
ADDITIONAL CAPACITY
CAPACITY ADDITION
MULTIPLIER
LOANS & ADVANCES
PROCUREMENT RATE
FINALISATION OF
CAPACITY ADDITION
DEMAND FULFILLING FACTOR
PROFIT AFTER TAX
RE INVESTMENT FRACTION
PERIOD
NORMAL CU
LOANS &ADVANCES
REQUIRED

173
Figure 2. Standard run of demand of product and installed capacity of the company
Figure 3. Demand and Capacity Stock- flow diagram
9:41 PM Tue, Oct 22, 2013
Untitled
Page 1
1.00 2.25 3.50 4.75 6.00
Years
1:
1:
1:
2:
2:
2:
30
45
60
3
5
6
1: DEMAND OF PRODUCT 2: INSTALLED CAPACITY
1
1
1
1
2
2
2
2
SALES
SALES
TOTAL CORPORATE
PERFORMANCE
CORPORATE PERFORMANCE
INDEX
WEIGHTAGE ON INSTALLED CAPACITY
DESIRABLE CORPORATE
PERFORMANCE
INSTALLED CAPACITY
~
CP POINT IN % DUE TO
INSTALLED CAPACITY
INSTALLED CAPACITY
WEIGHTED POINT ON CP
NO OF EMPLOYEE
~
CP POINT IN % DUE
TO EMPLOYEE
EMPLOYEE WEIGHTED
POINT ON CP
WEIGHTAGE ON NO
OF EMPLOYEE
NO OF SHAREHOLDERS
SHAREHOLDERS
~
CP POINT IN %DUE
TO SHAREHOLDERS
WEIGHTAGE ON NO
OF SHREHOLDERS 2
PROFIT AFTER TAX
PROFIT AFTER TAX
MARKET SHARE
MARKET SHARE
WEIGTHAGE ON
MARKET SHARE
~
CP POINT IN % DUE
TO MARKET SHARE
WEIGHTAGE ON PROFIT
AFTER TAX
~
CP POINT IN % DUE
TO PROFIT AFTER TAX
PERCENT INCREASE IN
MARKET SHARE
PROFIT AFTER TAX PER TMT
EMPLOYEE PER TMT
SHAREHOLDERS PER TMT
PERCENTAGE INCREASE
IN INSTALLED CAPACITY
IC IN RY
MS IN RY

174
Figure 4. Standard run of demand of product and installed capacity of the company
The process of validation progresses after having
the initial run often, if modeller finds some erroneous
and implausible results, by modifying some of the
erroneous structural relationships included in the
model by mistake or wrong assumptions or assumed
values, of some multipliers, or graph functions etc
(taken earlier with some assumptions) The model is
run for simulation again and again incorporating some
modifications each time, till valid output is obtained.
An attempt has been made to compare the model
behaviour with that of the actual data for employee,
shareholders, installed capacity, production capacity,
revenue, expenditure, return on investment, market
share etc as depicted in figures they show close
resemblance.
In the reference year installed capacity of the
company is 3500 MT and it increases year by year.
This table shows the comparison of actual vs.
simulated result.
Figure 5. The comparison of actual vs. simulated result
9:43 PM Tue, Oct 22, 2013
Untitled
Page 1
1.00 2.25 3.50 4.75 6.00
Years
1:
1:
1:
2:
2:
2:
2500
5000
7500
1500
5000
8500
1: EXPENDITURE 2: PROFIT AFTER TAX
1
1
1
1
2
2
2
2

175
5.5 Future Projection
For knowing the corporate performance in future
years say (2008 to 2017), reference year has been
changed to the year 2006-2007 and initial values of
variables and some other values taken accordingly,
keeping other values and relationships is structure of
the model unchanged for simulation. This means
without modify the structure of the model, the model
is run for simulation for next ten years.
The projected result shows for next ten years i.e.
2017, in 2007 installed capacity of the company is
6,000 MT/ year and it shall be double after 3 years
(2010) and in 2017 it shall be 22,950 MT. Even
company wants to double its capacity by 2010.
Demand of product in the country is shall be
from 51,000 MT to 110,000 MT from 2007 to 2017.
11th
Five Year Plan of India (ministry of steel) and
National Steel Policy of India indicated the demand
growth will be 121,000 MT by 2019.
Figure 6. Future projected result of demand of product, installed capacity and actual production of the
company
6. Conclusion
System Dynamics is a powerful method to gain useful
insight into situations of dynamic complexity and
policy resistance. It is increasingly used to design
successful policies in companies and public policy
settings. In this paper we reported an ongoing
research effort to study the performance of corporate.
iThink©
software has been extensively used to
develop a comprehensive system dynamics model of
corporate performance. We have also utilised the
computer simulation tools of the software to handle
the high complexity of the resulting feedback model.
System dynamics model for the corporate
performance developed has been put to generate
model behaviour by simulating using solution interval
1 year and 6 years as simulation run length with initial
values for the year 2001. For future projection,
solution interval is 1 and simulation length is 10 yrs
with initial value for the year 2007.
The performance of corporate lies not only in
having efficient plan but by implementing the plan
efficiently to enhance the desired performance
without much of deviations.
References
1. Beaver G. (2000), Strategy, performance and
governance: the sensitivity of remuneration, Journal of
Strategic Change 9(6): September/October, 327-331
2. Bonoma, T. V. & Clark, B. H., 1998, Marketing
Performance Assessment”, Harvaed Business School
Press, Boston.
3. Brayn, Lowell L. (2007) The new metrics of corporate
performance: Profit per employee, Mckinsey Quaterly
4. Brown D.Michael (1994) Measuring corporate
performance, Long Range Planning, Volume 27, Issue
4, August 1994, Pages 89–98
5. Brugnoli Carlo (1999), System Thinking and
Corporate Stagey, System Dynamics conference
Procedding, 1999
6. Cheng, Shijun (2008), Board size and the variability of
corporate performance, Journal of Financial Economics,
Volume 87, Issue 1, January 2008, Pages 157–176
7. Clark, B. H. 1999, “Marketing Performance Measures:
History and Interrelationships”, Journal of Marketing
Management, Vol. 15, pp. 711-732.
8. Collins, Jim (2001) Good to Great: Why Some
Companies Make the Leap...and Others Don’t,Random
House
9. Coyle R. G., (1972), The Dynamics of a Mining
Enterprise, 10th
International Conference on decision
making in the Mineral Industry, Johannesburg.
10. Dahya, Jay; McConnell, John J.; Travlos, Nickolaos G.
(2002), The Cadbury Committee, Corporate
Performance, and Top Management Turnover, The
Journal of Finance, Volume 57, Issue 1, pages 461–483,
9:38 PM Tue, Oct 22, 2013
Untitled
Page 1
0.00 2.50 5.00 7.50 10.00
Years
1:
1:
1:
2:
2:
2:
3:
3:
3:
50
90
130
5
15
25
1: DEMAND OF PRODUCT 2: INSTALLED CAPACITY 3: ACTUAL PRODUCTION
1
1
1
1
2
2
2
2
3
3
3
3

176
11. Dahya ,
Jay and McConnell, John J. (2007), Board
Composition, Corporate Performance, and the Cadbury
Committee Recommendation, Journal of Financial and
Quantitative Analysis, Journal of Financial and
Quantitative Analysis, 42 : pp 535-564
12. Dangerfield B. C., (1986), System Dynamics as an aid
to the present day Corporate Strategic Policy Making,
2nd
European Simulation Congress, Antwerp, Belgium.
13. Daqing Qi, Woody Wu, Hua Zhang (2000),
Shareholding structure and corporate performance of
partially privatized firms: Evidence from listed Chinese
companies, Pacific-Basin Finance Journal Volume 8,
Issue 5, Pages 587-610
14. Fey W. R., (1962), An Industrial Dynamics Case study,
Industrial Management Review, 4(1), PP 79-99.
15. Firth, Michael;
Fung, Peter M.Y.; Rui Oliver M. (2006),
Corporate performance and CEO compensation in
China, Journal of Corporate Finance, Volume 12, Issue
4, September 2006, Pages 693–714
16. Folke, C. (2006). Resilience: The emergence of a
perspective for social–ecological systems analyses .
Global Environmental Change , 253-267 .
17. Forrester, J. (1961). Industrial Dynamics. Cambridge,
MA: MIT Press.
18. Gary, Michael Shayne; Kunc, Martin; Morecroft John
D. W. and Rockart, Scott F. (2008) System Dynamics
and Strategy, System Dynamics Review. 24, 407–429
19. Guest, David E.; Michie, Jonathan; Conway, Neil;
Sheehan, Maura (2003), Human Resource Management
and Corporate Performance in the UK, British Journal
of Industrial Relations, Volume 41, Issue 2, pages 291–
314,
20. Harold Demsetz and Belén Villalonga, (2001)
Ownership structure and corporate performance, Journal
of Corporate Finance, Volume 7, Issue 3, Pages 209-
233
21. http://steel.gov.in/overview.htm
22. http://steel.nic.in
23. http://steel.nic.in/dev2.htm
24. http://www3.inderscience.wiley.com/cgi-
bin/fulltext/85009266/PDFSTART
25. Irala, Lokanandha Reddy, Corporate Performance
Measures in India: An Empirical
26. Analysis, WP-2007/01/A available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=964
375
27. Ittner, C. D. & Larcker, D. F., 1998,”Innovations in
Performance Measurement: Trends and Research
Implication”, Journal of Management Accounting
Research, Vol. 10, pp. 205-238.
28. Joy, Lois; Carter, Nancy M; Wagner, Harvey M.; and
Narayanan Sriram (2007) The Bottom Line: Corporate
Performance and Women's Representation on Boards,
Catalyst Inc USA
29. Kalpan, R. S. & Norton, D. P., 1992, “The Balanced
Scorecard – Measures that Drive Performance”,
Harvard Business Review, January-February, pp. 71-79.
30. King P. D. A., Coyle R. G. and Wolstenholme E. F.,
(1983), A General System Model of Business
Performance, Proc. of the 1983, International System
Dynamics Conference, MIT, USA.
31. King P. D. A., Coyle R. G. and Wolstenholme E. F.,
(1983), A General System Model of Business
Performance, Proc. Of the 1983, International System
Dynamics Conference, MIT, USA.
32. Kokkinaki, F. & Ambler, T., 1999, “Marketing
Performance Assessment: An Exploratory Investigation
into current Practice and the Role of Firm Orientation”,
Marketing Science Institute, Working Paper, No. 99-
114.
33. Kumar R. and Vrat P., (1989), Using Computer Model
of Material Flow-Case of a Steel Plant, Proc.
International System Dynamics Conference, MIT, USA.
34. Legasto A. A and Maciariello J., (1980) System
Dynamics: A Critical Review, TIMS Studies in the
Management Science 14, PP 23-24.
35. Majumdar, S. (1997), “The Impact of Size and Age on
Firm-level Performance: Some Evidence from India”,
Review of Industrial Organization 112, 231-242
36. Mandal Purnendu, Love, Peter E. D., Gunasekaran, A.
(2002) , Towards a system dynamics modelling
framework for quality in manufacturing, International
Journal of Manufacturing Technology and Management
2002 - Vol. 4, No.3/4 pp. 333-343
37. Milling P. M., (1988), Subjective Knowledge Bases in
Corporate Policy Making, Proc. of the 1988
International Conference of System Dynamics Society,
La Jolla, CA.
38. Neely, A., Adams, C. & Kennerley, M. 2002, “The
Performance prim – the scorecard for measuring and
managing business success”, FT Prentice Hall, London.
39. Norburn, David; Birley, Sue (1998), The top
management team and corporate performance, Strategic
Management Journal, Volume 9, Issue 3, pages 225–
237,
40. Nobs, A., Minkus, A., & Rummert, A. (2007).
Implementing and Controlling an Operations Strategy in
Global Industrial Service Networks. In Advances in
Production Management Systems (pp. 19-26). Boston:
Springer
41. Perelman L.J., (1980), Time in System Dynamics,
TIMS Studies in Management Science 14, PP 75-89.
42. Phillillips, B. & Shanka, T., 2002, “Balanced Scorecard
(BSC) Measures in Small and Medium Enterprises
(SMEs) – An Exploratory Study”, in R. Shaw, S. Adam
& H. McDonald (eds.). Proceedings of the Australian
and New Zealand Marketing Academy Conference
(ANZMAC) 2002, Melbourne, Australia, pp. 2452-
2456.
43. Prasetyantoko, A. and Parmono, R. (2008),
“Determinants of Corporate Performance of Listed
Companies in Indonesia” from http://mpra.ub.uni-
mucnchen.de/6777/MPRA-paper-6777.pdf
44. Rahdari, Hossein; Forouzan, Alireza; Ramezankhani,
Atefeh; Foroughi Pouyan (2007), Analyzing the Effect
of Global Steel Price Fluctuation on Iran's Steel-Maker
Stock Prices: A System Dynamics Approach, retrieved (
may 2012) from
http://www.systemdynamics.org/conferences/2009/proc
eed/papers/P1137.pdf
45. Renée B. Adams, Heitor Almeida, Daniel Ferreira
(2005), Powerful CEOs and Their Impact on Corporate
Performance, Review of Financial Studies, Volume18,
Issue4, Pp. 1403-1432 available at
http://rfs.oxfordjournals.org/content/18/4/1403.short
46. Reserve Bank of India’s Report,
2001,2002,2003,2004,2005,2006,2007
47. Richard et al. (2009): Measuring Organizational
Performance: Towards Methodological Best Practice.
Journal of Management.
48. Roberts N., (1983), Computer Simulation using System
Dynamics, Adison-Wesley, Reading, Massachusetts.
49. Sahay, Mridula (2011) Corportat Strategy through
System Dynamics, System thinking and System

177
Dynamics, System Thinking and System Dynamics,
Macmillan Publishers India Ltd., India pp. 64-75
50. Sahay S. S., (1984), Some Studies on a Comprehensive
Procedure for corporate Long Range Planning Using
System Dynamics and Goal Programming Techniques,
Ph. D. Thesis, Indian Institute of Technology,
Kharagpur.
51. Senge, P. (1990). The Fifth Discipline. Garden City,
NY: Doubleday Currency.
52. Sheth, J. N. & Sisodia, R. S., 1995, “Feeling the Heat”,
Marketing Management, Vol. 4, No. 2, pp. 8-23.
53. Simon, H. (1979). Rational Decision Making in
Business Organizations. The American Economic
Review , 493-513 .
54. Spencer R. S., (1966), Modeling Strategies for
Corporate Growth, Conf. of American Association for
the Advancement of Science, Washington D. C.
55. Sterman, J. D. 2003. Business Dynamics: Systems
Thinking and Modelling for a Complex World, McGraw
Hill
56. Steve Engelen, Hilda Meersman, & Eddy Van De
Voorde (2006), Using system dynamics in maritime
economics: an endogenous decision model for
shipowners in the dry bulk sector, Maritime Policy &
Management, Volume 33, Issue 2, pp 141-158
57. Vij A. K., Vrat P., Sushil, (1987), Application of
System Dynamics to Energy Modeling in the National
Economy – Conceptual Framework, Proc. Second
National Conference on System Dynamic Varanasi,
January 15-17, 1987.
58. Wheelen, T. L. & Hunger, D. J., 2002, “Startegic
Management and business policy” 8th
Ed. Prentice Hall,
New Jersey.
59. Wiener N., (1948), Cybernetics on Control and
Communication in the Animal and Machine, MIT Press.
60. Wolstenholme E. F. and Coyle C. G., (1983), The
Development of System Dynamics as a Methodology
for System Description and Quantitative Analysis, Jr.
Operations Research Society, 34(7), PP 569-581.
61. Wright R. D., (1971), Industrial Dynamics
Implementation: Growth Strategies for a Trucking Firm,
Sloan Management reviews. 13(1), PP 71-86.
62. www.tatasteel.com
63. .World Steel Industry, Economic Watch June 2010,
retrieved from http://www.economywatch.com/world-
industries/steel-industry/?page=full on May 2012

178
THE EFFECT OF CORPORATE GOVERNANCE ON BANK
FINANCIAL PERFORMANCE: EVIDENCE FROM THE
ARABIAN PENINSULA
Mohamed A. Basuony*, Ehab K. A. Mohamed**, Ahmed M Al-Baidhani***
Abstract
This paper investigates the effect of internal corporate governance mechanisms and control variables,
such as bank size and bank age on bank financial performance. The sample of this study comprises of
both conventional and Islamic banks operating in the seven Arabian Peninsula countries, namely
Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates, and Yemen. Regression analysis
(OLS) is used to test the effect of corporate governance mechanisms on bank financial performance.
The results of this study reveal that there is a significant relationship between corporate governance
and bank profitability. Board size, board activism, number of outside directors, and bank age
significantly affect Tobin’s Q. Meanwhile, ROA and PM are affected by ownership concentration, audit
committee, audit committee meetings, and the age & size of the bank. The results are consistent with
previous literature that the correlation between corporate governance and firm performance is still not
clearly established and that impact of corporate governance on bank financial performance in
developing countries is still relatively limited.
Keywords: Board Structure, Ownership Structure, Audit Committee, Corporate Governance
Mechanisms, Bank Performance, GCC, Yemen
* American University in Cairo, Egypt
** Professor of Accounting & Vice of Academic Affairs, Faculty of Management Technology, German University in Cairo, New
Cairo, Post Code: 11835, Cairo, Egypt
Tel.: 20 227590764
Fax: 20 227581041
Email: ehab.kamel@guc.edu.eg*** German University in Cairo, Egypt
1. Introduction
Corporate governance has become one of the most
topical issues in the modern business world today.
Spectacular corporate failures, such as those of Enron,
Worldcom, Barlow Clows and Levitt, the Bank of
Credit and Commerce International (BCCI), Polly
Peck International and Baring Bank, have made it a
central issue, with various governments and
regulatory authorities making efforts to install
stringent governance regimes to ensure the smooth
running of corporate organizations, and prevent such
failures. A corporate governance system is defined as
a more-or-less country-specific framework of legal,
institutional and cultural factors shaping the patterns
of influence that shareholders (or stakeholders) exert
on managerial decision-making. Corporate
governance mechanisms are the methods employed, at
the firm level, to solve corporate governance
problems.
Corporate governance is viewed as an
indispensable element of market discipline (Levitt
1999) and this is fuelling demands for strong
corporate governance mechanisms by investors and
other financial market participants (Blue Ribbon
Committee 1999; Ramsay 2001). Regulators have
enacted corporate governance reforms into law in
many countries such as the USA (Sarbanes-Oxley
Act, 2002). In other countries such UK (Combined
Code of Corporate Governance, 2003) the corporate
governance codes are principles of best practice with
some indirect element of legislature operating through
the respective stock exchange listing rules. For the
banking sector, Basel II is widely adopted by
developing and emerging market economies to
enhance their CG codes.
Bank governance was altered tremendously
during the 1990s and early 2000s, principally due to
bank ownership changes, such as mergers and
acquisitions (Berger et al. 2005; and Arouri et al.
2011). The worldwide financial crisis of 2008, which
started in the United States, was attributable to U.S.
banks’ excessive risk-taking. Consequently, in order
to control such risk and draw people’s attention to the
agency problem within banks, there are statements
made by bankers, central bank officials, and other
related authorities, emphasizing the importance of
effective corporate governance in the banking
industry since 2008 and until now (Beltratti and Stulz
2009; and Peni and Vahamaa 2011). Therefore, any

179
similar crisis occurred or may occur in the future
might be explained as a result of bank governance
failure. Few studies have focused on banks’ corporate
governance (see Macey and O’Hara, 2003; Levine,
2004; Adams and Mehran, 2005; Capiro et al. 2007;
Bokpin, 2013; Nyamongo and Temesgen, 2013).
This study focuses on banks operating in Yemen
and the GCC countries in order to provide empirical
evidence on the effects of corporate governance on
bank performance. The rest of the paper is organised
as follows: the following section provides a
theoretical background and hypotheses development.
The research methodology is provided in section 3,
followed by the findings and analysis in section 4; and
finally summary & conclusion are provided in
section 5.
2. Theoretical Background and
Hypotheses Development
2.1 Background
Traditional finance literature has indicated several
mechanisms that help solve corporate governance
problems (Jensen and Meckling (1976); Fama (1980);
Fama and Jensen (1983); Jensen (1986); Jensen
(1993); and Turnbull (1997). There is a consensus on
the classification of corporate governance
mechanisms to two categories: internal and external
mechanisms. However, there is a dissension on the
contents of each category and the effectiveness of
each mechanism. In addition, the topic of corporate
governance mechanisms is too vast and rich research
area to the extent that no single paper can survey all
the corporate governance mechanisms developed in
the literature and instead the papers try to focus on
some particular governance mechanisms.
Jensen (1993) outlines four basic categories of
individual corporate governance mechanisms: (1)
legal and regulatory mechanisms; (2) internal control
mechanisms; (3) External control mechanisms; and
(4) product market competition. Shleifer and Vishny
(1997) concentrate on: incentive contracts, legal
protection for the investors against the managerial
self-dealing, and the ownership by large investors;
they point out the costs and benefits of each
governance mechanism. Denis and McConnell (2003)
use a dual classification of corporate governance
mechanisms (They use systems as synonym to
mechanisms) as follows: (1) internal governance
mechanisms including: boards of directors and
ownership structure and (2) external ones including:
the takeover market and the legal regulatory system.
Farinha (2003) surveys two categories of
governance (or disciplining) mechanisms, the first one
is the external disciplining mechanisms including:
takeovers threat; product market competition;
managerial labour market and mutual monitoring by
managers; security analysts; the legal environment;
and the role of reputation. The other category is the
internal disciplining mechanisms which include: large
and institutional shareholders; board of directors;
insider ownership; compensation packages; debt
policy; and dividend policy.
Despite the existence of different corporate
governance structures, the basic building blocks of the
structures are similar. They include the existence of a
Company, Directors, Accountability and Audit,
Directors’ Remuneration, Shareholders and the AGM.
Cadbury (1992), Greenbury (1995) and Hampel
(1998) called for greater transparency and
accountability in areas such as board structure and
operation, directors’ contracts and the establishment
of board monitoring committees. In addition, they all
stressed the importance of the non-executive
directors’ monitoring role. The relationship between
corporate performance and corporate governance is
measured using only one of the two variables:
ownership structure and board structure (Krivogorsky,
2006).
Much of the empirical findings on corporate
governance and performance in non-financial
institutions are also applicable to financial
institutions. However, the optimal designing of bank
governance structure is very complex and important
relative to unregulated, non-financial firms for several
reasons. Mullineux (2006) argues that good CG of
banks requires prudential risk-related regulation and
attention to conflicts of interest and competition
issues, particularly given the clear information
advantage of banks over their retail customers. Banks
are prudentially regulated and highly levered
compared to other companies and hence bank
governance deserves special attention (Adams and
Mehran 2003).
Moreover, the stakeholders’ interests at banks
extend beyond the shareholders’ interests since the
bank depositors, creditors, and regulators have stakes
in the banks as well. In addition to shareholders and
managers, depositors and regulators have a straight
stake in bank performance. Griffiths (2007) argues
that borrowers have a legitimate claim on banks by
entering in lending agreements, acquire power and
urgency through their cause being adopted by other
stakeholders such as regulators and consumer
organisations. These stakeholders enjoy all three of
Mitchell et al. (1997) stakeholder attributes: power,
legitimacy and urgency (Yamak and Su¨er, 2005;
Griffiths, 2007). Governments are also worried about
banks reputations, and consequently regulate their
governance, because a bank’s failure negatively
affects the respective country’s economy, and may
even spread globally, similar to what happened during
the 1997 Asian financial crisis (Pathan et al. 2008)
and the 2008 U.S. financial crisis (Peni and Vahamaa
2011).
Abu-Tapanjeh (2009) compares the OECD
corporate governance principles with principles from
Islam and declares them compatible; he points out
that Islam as applied to business is entirely

Coc volume_11_issue_2_winter_2014_continued1_

Coc volume_11_issue_2_winter_2014_continued1_

Recommended

Recommended

More Related Content

Similar to Coc volume_11_issue_2_winter_2014_continued1_

Similar to Coc volume_11_issue_2_winter_2014_continued1_ (20)

More from Dr. Ahmed M. Al-Baidhani

More from Dr. Ahmed M. Al-Baidhani (12)

Recently uploaded

Recently uploaded (20)

Coc volume_11_issue_2_winter_2014_continued1_