Organizational Structure, Corporate Governance, Audit Quality, and Performance

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Organizational Structure, Corporate Governance,
Audit Quality, and Performance

• Gene C. Lai
• genelai_at_wsu.edu
• Washington State University
• Feng Chia University
• Presented at NCCU (TRIA)

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Introduction

• This presentation is based on our (with my
  co-authors) published and unpublished work.

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My co-authors

• Thomas Berry-Stölzle
• Li-Rhu Chen
• Liying Huang
• Vision Huang
• Vivian Jeng
• Piman Limpaphayum
• Michael McNamara
• Jennifer Wang
• Sabine Wende

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Outline

• Performance
• Organizational Structure
• Corporate Governance
• Audit Quality
• Specialization
• Special Characteristics of Various Countries
• Structure Changes
• Results
• Conclusion

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Performance

• Profitability (ROA, ROE)
• Tobins Q (Market value)
• Not suitable when mutuals involve
• Efficiency scores

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Efficiency Scores

• Parametric approach (e.g., the stochastic
  frontier approach)
• Non-parametric approach (e.g., the DEA approach)

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DEA Approach

• The value-added approach
• More popular
• But suffer certain disadvantages
• Loss as output
• Use number of policy as output is better
• The financial intermediary approach

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Organizational Structure

• Stock insurers (U.S., Japan, Germany, )
• Mutual insurers (U.S., Japan, Germany, )
• Fraternal insurers (U.S.)
• Public insurers (Germany)
• Keiretsu insurers vs. independent insurers
  (Japan)
• Chaebol (Korea)

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Organizational Structure and Hypothesis

• Expense hypothesis (Mutuals)
• Co-existance hypothesis (Efficiency sorting
  hypothesis)
• Managerial hypothesis (Stocks vs. Mutuals)
• Public hypothesis
• Keiretsu hypothesis

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Corporate Governance

• It has become a more important issue recently.

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Corporate Governance (2)

• The Asian crisis in 1997 and corporate scandals
  such as Barings, WorldCom, and Enron have
  highlighted the need for corporate governance
  reform at a global level (Demirag and Solomon,
  2003).

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Corporate Governance (3)

• The passage of the Sarbanes Oxley Act of 2002
  (SOX) was to respond to the accounting scandals
  mentioned above and several other large
  corporations.
• This regulation imposes a number of corporate
  governance guidelines on all publicly traded
  companies in the U.S.

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Corporate Governance (4)

• Despite the claimed benefits of this Act, the
  passage of the SOX gives rise to a broader
  concern that the SOX could signal a shift to a
  more rigid federal and state regulation of
  corporations, thereby causing that the direct and
  indirect costs of the SOX can outweigh its
  benefits.

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Corporate Governance (5)

• Insurance industry serves as a good research lab
  to examine whether imposing additional
  regulations on corporate governance as guided in
  the SOX Act can enhance the performance for this
  already highly-regulated industry.

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Hypothesis (Corporate Governance) (1)

• Hypothesis 1 There is no relation between board
  independence and firm performance.
• Hypothesis 2 There is no relation between the
  number of board meetings and firm performance.

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Hypothesis (Corporate Governance) (2)

• Hypothesis 3 There is no relation between the
  separation of the CEO from board chairman and
  firm performance.
• Hypothesis 4 There is no relation between the
  proportion of management shareholding and firm
  performance.

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Hypothesis (Corporate Governance) (3)

• Hypothesis 5 There is no relation between the
  independence of compensation committee and firm
  performance.
• It should be noted that there are many other
  corporate governance variables can be included in
  the analysis

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Audit Quality (1)

• Audit quality has become more important issues
  recently.
• Initiatives to improve audit committee quality
• Blue Ribbon Committee (1999)
• SOX (Section 406 and 407, 2002)
• SEC (2003)
• NAIC (Model Audit Rule Section 16, 2006)

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Audit Quality (2)

• Audit committee of board of directors the main
  responsibility is to oversee the corporate
  financial reporting process

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Hypothesis (Audit Quality) (1)

• Hypothesis 1 There is no relation between the
  audit committee size and firm performance.
• Hypothesis 2 There is no relation between the
  financial expertise on the audit committee and
  firm performance.

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Hypothesis (Audit Quality) (2)

• Hypothesis 3 There is no relation between the
  number of audit committee meetings and firm
  performance.
• Hypothesis 4 There is no relation between the
  auditor independence and firm performance.

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Hypothesis (Audit Quality) (3)

• It should be noted that there are many other
  audit quality variables can be included in the
  analysis

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Specialization vs. Non-specialization

• Independent firms in Japan can be categorized
  into
• Specialized insurers
• Non-specialized insurers
• U.S. property-liability insurers
• Specialized insurers
• Non-specialized insurers

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Special Characteristics of Various Countries (1)

• China State-owned insurers
• Germany
• Public insurers
• Japan
• Keiretsu vs. independent firms
• Specialized vs. non-specialized firms

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Special Characteristics of Various Countries (2)

• Taiwan
• Family owned, Financial Holding companies,
  foreign companies
• U.S.

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Structure Changes (1)

• Taiwan
• Liberalizations and Deregulations (open to
  foreign insurers, open to new domestic insurers)
• Japan
• Bubble, deregulation
• Germany
• Reunification, deregulation

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Structure Changes (2)

• U.S.
• The Sox
• Malmquist index analysis is a wonderful tool to
  analyze time series structure changes

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Results (1)

• Organization structure sometimes matters,
  sometimes does not. (e.g., Japan, Germany, U.S.)
• Many governance mechanisms matters. For example,
  board independence, the separation of the CEO
  from board chairman, auditor independence, and
  compensation committee independence have
  significant effects on firm performance in U.S.
  life insurance industry.

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Results (2)

• It should be noted that some corporate governance
  variables have significant effect in one study,
  but not in another study.
• The effect of audit quality variables on
  performance is similar to that of corporate
  governance variables.
• Liberalization and deregulation usually increase
  the performance.
• Liberalization and deregulation have different
  impact on different organization structure.

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Conclusion (1)

• Organizational structure, corporate governance,
  audit quality have impact on the performance,
  respectively.
• Liberalizations and deregulations improve
  performance.
• Various country studies provide interesting
  results.

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Conclusion (2)

• Other relevant issues
• Demutualization
• Extension
• Earning management (accounting)
• Reserve error management (insurance)
• Risk taking