Corporate governance's relationship with environmental performance

¶ … Corporate Governance and Environmental Performance

In corporate governance literature, there is no generally accepted definition of the corporate governance concept. However, companies, organizations, investors and other users define the concept according to their perception. In addition, there exists various definitions of corporate governance, and some of the definitions present corporate governance as a system, which is core to the control and directing of a company. On the other hand, there are definitions that stress the activism of investors, presenting their significance in corporate governance. From such a view, the corporate governance refers to the relationship between the firm and shareholders. In this case, the shareholders advocate for best practices, and include the efforts of the shareholders in achieving the company's goals. Other definitions focus on observing regulations or the success of the company. Therefore, corporate governance represents all activities that represent internal regulations of the firm aiming at observing legal, shareholders, and control obligations (Lenciu, 2001).

Corporate governance is a crucial issue in practice, and companies aim to influence stakeholders, including the public and the environment positively. Most importantly, corporate concerns on the environment have become prominent in business management. Nevertheless, there is still a large gap between a company's image and the environmental performance, as evident owing to public demand for accountability and transparency. Corporate governance is an important aspect, which can strengthen investor confidence in management. Prior literatures provide empirical evidence, which states that a company's environmental performance has a positive impact on the firm's performance. In addition, several literatures suggest that equity investors are against some of the strategies from the management dealing with environmental issues. Moreover, it is apparent that may companies, through their managers, tend to engage in pro-active strategies to eliminate or reduce the rates of pollution. Nevertheless, some companies benefit after developing unique strategies related to their environmental efforts.

The topic of corporate environmental management and performance has drawn attention from a good percentage of investigators. Owing to this, some investigators have delivered substantial information on why corporate governance may have a positive relationship with environmental performance. Melnyk et al. (2003) proved that such a positive link exists when firms commit to implement environment management systems, and other authors including Kock and Santalo (2005) found contradictory results on the issue of whether environmental performance and shareholder wealth have a positive relation. In addition, some prior studies focused on the interactions that exist between corporate governance and environmental issues. Some studies advocate for use of models of what incentives the management can use to sway low-level managers to take part and advocate for programs on environmental activities. Initially, most firms used the environment as a free source to deposit waste materials, but legislation attempted to eliminate this issue. On the other hand, this concept changed, and firms later started utilizing environmental management systems, which aimed at handling the environmental issue.

Background, Theory and Hypotheses

The firm's environmental practices have turned into a significant subject in the society, with a variety of stakeholders anticipating environmental accountability. As the societal expectations concerning the firm's environmental responsibilities rise, the environmental performance is becoming a field where companies can identify strategic opportunities. In addition, environmental performance is capable of reducing operating costs, progress entry to resources, and attracts consumers and retains the best employees. For instance, the study by Price Water House Coopers found out that over 40% firms felt that the "green movement" has the capacity to create market opportunities, as made apparent by the increase in customer demand for green products and services. In addition, some case studies by the World Business Council for Sustainable Development suggest that sound environmental performance can result in reduced fuel, energy, and costs of water. Therefore, limiting environmental impacts can result in reduced risk of facing legal sanctions, higher insurance costs, and substantial remediation costs.

Furthermore, another consequence of societal expectations is that there is a potential of risk in incurring environment related liabilities. Environmental calamities, such as oil spills from oil firms suggest that environmental issues can result in high costs, for instance, when companies may be required to pay clean-up costs, fines, and settlements for legal sanctions. In such cases, firms stand to lose substantial amounts of their profits. Countries continue to make laws on the issue of environment, for instance, the annual environmental protection and superfund cleanup costs for firms based in the United States have increased substantially. Owing to the connection in environmental performance and strategic advantages, sound environmental performance will be of interest to the investors. Klassen and McLaughlin (1996) found out that positive stock market returns have a connection to environmental performance awards. On the other hand, Russo and Fouts (1997) found out that there exists a positive relationship between the financial status of a company and environmental performance.

In addition, another study by Dowell, Hart and Young (2000) suggests that companies that adopt a sound environmental standard have a higher market value. In addition, companies that lead in the environmental initiatives have the capacity to gain a competitive advantage, when compared to those that do not. Nevertheless, Barnett (2007) suggests that some companies may adopt some environmental strategies not because they want to, but because some stakeholders advocate for the strategies. Although substantial prior literature suggests that, there is strategic significance of sound environmental performance; management might choose not to follow the trend. This may arise because environmental performance strategies require substantial investments, and most of them are long-term in nature. Such a characteristic is capable of making risk adverse managers to avoid undertaking such environmental initiatives. In addition, the management may be hesitant to incur expenses that may not be able to bring about immediate returns, and, therefore, opt to pursue short-term initiatives, which have the capacity to maximize their reputational and financial status.

Hypothesis Development

Board Size and Environmental Performance

Prior studies suggest that a large board will bring prior experience and knowledge, which will offer understanding and better advice to the company. In addition, a large board is likely to include professionals, from various and particular issues, for instance environmental performance. In support of this, Booth and Deli (1996) suggest that environmental uncertainty will result to large board sizes. In so doing, this composition will allow the firms to handle such environmental uncertainty because of the professionals constituting the board. Most importantly, a large board can include prestigious directors, and this is an important aspect, in relation to the resource dependent related aspect. Prior evidence shows that firms, which need advice, derive greater value from larger boards. Nevertheless, substantial prior literatures suggest that firms with a large board have low costs of debt and low variability of corporate performance, experience improved governance disclosure and low stock price vitality, better disclosure in relation to compensation practices, improved firm performance and a decreased probability of bankruptcy. In this case, it is arguable that a large board is likely to include experienced and knowledgeable directors who posses expertise when it comes to managing environmental issues. Therefore, the hypothesis derived is that there exists a positive relationship between the size of the board and environmental performance.

CEO Duality and Environmental Performance

Combining the roles of the CEO and board chairperson has the capacity to influence the CEO's undue influence over the board, which can subsequently reduce the ability of the board to monitor. In addition, CEO duality has the capacity to increase information asymmetry amid the CEO and the board. In so doing, this can be a source of agency challenges, for instance, this can undermine the efficiency of the oversight roles of the board. A typical example is that a CEO can monopolize the meetings held by the board, by choosing some agenda items (Kelton and Yang, 2008). In addition, empirical evidence suggests that CEO duality to unfavorable results for stakeholders, including excessive managerial compensation, earnings management, and adoption of poison pills, international political risk, bankruptcy, and financial misreporting. This suggests that in case a firm faces an environmental opportunity, the CEO-chairperson has the capacity to increase the possibility of the company focusing on the short-term reduction of costs, at the expense of reaching for long-term environmental opportunities. Owing to this, the hypothesis, which fits such a situation, is that there is a negative relationship between CEO duality and environmental performance.

Board Meetings and environmental performance

According to the many prior literatures provided in respect to the relationship between the board of director's attributes and the performance of the company, studies provide mixed results. This is there are positive and negative, and no relationship existing amid the attributes of the board of directors and the performance of the firm. In a study conducted by Conger (1998), the study shows that there is a positive connection between the board meeting and the performance of the firm. In another study, the authors found out that there is a negative relationship between the board meeting and the performance of the firm. On the other hand, members of the board comprise of two categories and they include non-executive directors, and the executive directors. However, some scholars found out that there was a positive relationship between non-executive directors and the performance of the firm, whereas Bhagat and Black (1999) found out that there was a negative relationship between the non-executive directors and the performance of the firm. However, other studies did not found any significant relationship between the non-excretive directors and the performance of the firm.

Audit Committee Independence and environmental performance

The outcomes of the relationship amid the audit committee independence and the performance of the firm are somewhat ambiguous. However, Chan and Li (2008), from their study found out that the independence of the audit committee, for instance, to have at least 40% of expert-independent managers serve on the audit committee, would positively influence the performance of the company. In addition, Ilona (2008) found out that there is a positive relationship amid the audit committee independence and the performance of the firm. Furthermore, Erickson et al. (2005) suggested that when directors are independent, this could work well to reduce many problems that may arise in the company. Based on this argument, that independent directors can reduce such firm problems, it is possible to argue that an independent committee audit can reduce the firm's problems. In simple words, a positive relationship amid the independence of the audit committee and the performance of the company is justified. Owing to the discussion provided, the apparent hypothesis is that there is a positive relationship, which exists amid the independence of the audit committee and the firm's performance.

Compensation Committee Independence and environmental performance

Currently, the compensation committee has become engaged in corporate decisions, and in terms of the efficiency of the boards, it is significant to note that the sub-committees under take most of the board functions. In regards to the design of pay schemes, the compensation committees are the most significant sub-committee immediately under the board of directors. For most firms, the decision of management pay is delegated to the compensation committee, of the board of directors. In addition, the compensation committee plays a significant role in establishing the CEO pay schemes in the interest of the company. However, there has been inadequate evidence concerning the characteristics and efficiency of the compensation committees. Newman and Mozes (1999) investigated the relationship between the compensation schemes and executive compensation, and their study shows that the sensitivity of executive pay to performance is low, especially when there is a member of the committee who is an insider. This suggests that the relationship between CEO compensation and firm performance favors managers, when there is an insider in the committee. On the other hand, Conyon and Peck (1998) provide evidence that firms that have committee members who are all outsiders such a committee is in line with the firms performance. The hypothesis apparent is that the connection existing amid management pay and firm performance tends to be stronger in firms that adopt compensation committees.

Nomination Committee Independence and environmental performance

Most importantly, board members comprise a significant part of the committees. This means that it is beneficial to examine the different elements that make up the committees. Prior studies have recommended the utilization of different committees to oversee the many activities, which occur within the organization. For instance, such committees include the audit, nomination, and environmental committees. These committees are significant, and they have the capacity to reduce some of the problems, which might arise within the organization. For instance, the audit committee, and nomination committees will ensure that the financial procedures of the company occur within the laws of the firm. Felo, Krishnamurthy and Solieri (2003), through their study explored the relationship between expertise, independence, and the composition of the audit committees and the quality of reporting financial matters. The study suggests that expertise and size have a positive relationship to financial reporting quality, but the two have no relationship to the independence of the committee. In addition, the study comments that given prior evidence of a negative relationship between the quality and cost of capital, the firms could advance the quality of reporting financial matters by properly structuring the audit committees. When the firm does this, the firm will reduce the costs of capital. Nevertheless, the presence of committees in a firm will have a positive impact on reducing the cost when measured on a scale of cost to revenue (Reddy et al., 2010). In addition, an effective nomination committee will ensure that the appointment of non-director is in line with the interests of shareholders and subsequently reduce the firm's problems. In this context, the apparent hypothesis is that there will be a positive relationship between the nomination committee and the performance of the firm.