The Relationship Among Corporate Governance, Diversification Strategy And Financial Performance

In recent years, the theoretical circle and the business community are very concernedabout the quality of corporate governance as the most important decision-making factors. C.Collins&Jerry I. Porras (1994) reveal the Everlasting secret of enterprise through thecomparison of the18century-old outstanding enterprises with its rival company. The mostimportant one is that a great company must have an independent and effective corporategovernance mechanism. Li Xiaoxue (2012), the executive vice president of Chinese ListedCompanies Association, pointed out that corporate governance attracted world attentionincreasingly in the trend of economic globalization. A good corporate governance is animportant mean to promote the standardized operation of the company, to build marketconfidence, to attract long-term investment. And it is also an important foundation toenhance the transparency of the market, to protect the interests of investors, and to promotecapital markets for steady and healthy development.The financial crisis in2008is harming to the various trades and industries with varyingdegrees. So the diversified investment theory of Markowitz is instituted again. Manycompanies began to stretch their tentacles to different assets, business and geography, so asto enhance damping capacity in a crisis. In practice, because of the limited capital, low brandawareness, weak technology development capability, imperfect market network, lowdiversification management level, people had a hunch that the small and medium enterprises(SMEs) should not engage in diversification. However, the survey shows that diversificationstrategy is the first strategy of20.7percent of SMEs, while is the second strategy of43percent of SMEs. A number of SMEs become large enterprises by adopting diversificationstrategy(Zhifang Meng&Zhijun Chen,2005).Corporate governance is more emphasis on scientific decision-making, while thebalance of powers, as the institutional arrangements to coordinate the powers andresponsibilities of parties involved in the company (Weian Li,2001). Corporate governancecharacteristics will inevitably affect the decision-making in the choice of diversificationstrategy decisions to one of the important strategic decision, the diversification strategy, thusaffecting the effect of the company’s diversification strategy on corporate financialperformance. Thus, only the listed companies adjust and improve its governance structureand mechanism timely, establish an effective supervision and control mechanism, handleinternal contradictions and conflicts triggered by the implementation of diversification well,can ensure the success of the implementation of the diversification strategy and the improvedof financial performance. Listed companies on GEM are of high growth, flexible operating mechanism,prominent diversify and innovative features. But they operate with uncertainty and the risk ismore complex. Therefore, the perfect corporate governance and smooth implementation ofdiversify are of more theoretical and realistic significance to listed companies on GEM. Thescientific decision-making and successful implementation of diversification strategy, as animportant part of the company’s strategy, depends primarily on the level of corporategovernance. So it may improve the performance. What is the relationship between corporategovernance and diversification strategy of listed companies on GEM? How candiversification strategy impact financial performance? What role of diversification strategyto play in corporate governance and financial performance? These are the main issues to besolved in this paper.At first, we review on the principal-agent theory, stakeholder theory, corporateentrepreneurship theory and enterprise growth theory. Then, analyze the profile of listedcompanies on GEM from the three perspectives of corporate governance, diversificationstrategy and financial performance. After that, comb the theoretical literature about theinteraction among corporate governance, diversification strategy and financial performanceof domestic and foreign scholars. And then, construct the relationship model amongcorporate governance, diversification strategy and financial performance. At last, empiricaltest on the model with the data of existing GEM listed company and obtained thecorresponding empirical results. Analysis of these empirical results of this studysystematically, the conclusions are as follows:1. Study on the mechanism of ownership structure, board governance, managerialincentives, stakeholder governance on the financial performance. In general, the results showthat the various dimensions of the corporate governance of companies listed on GEM havesignificant influence on financial performance. Ownership concentration and financialperformance was negatively correlated. Proportion of tradable shares and financialperformance negatively correlated. Board size and financial performance negativelycorrelated. The relationship between the function of the Board structure and financialperformance was ‘U-shaped’. Shares held by senior executives and financial performancenegatively correlated. Executive remuneration and financial performance are positivelycorrelated. Stakeholder governance and financial performance was ‘inverted U-shaped’correlation. However, the relationship between the proportion of independent directors andfinancial performance is not significant.2. Study on the mechanism of ownership structure, board governance, managerialincentives, stakeholder governance on the diversification strategy. In general, the resultsshow that the various dimensions of the corporate governance of companies listed on GEMhave significant influence on diversification strategy. Ownership concentration anddiversification strategy was negatively correlated. Proportion of tradable shares and diversification strategy negatively correlated. Proportion of independent directors anddiversification strategy negatively correlated. The function of the Board structure anddiversification strategy negatively correlated. Shares held by senior executives anddiversification strategy negatively correlated. Executive remuneration and diversificationstrategy negatively correlated. Stakeholder governance and diversification strategy arepositively correlated. However, the relationship between the board size and diversificationstrategy is not significant.3. Examines the the impact of the diversification strategy of the companies listed onGEM to its financial performance based on the actual situation of GEM in China. The resultsshow that diversification strategy and financial performance are positively correlated.Diversification strategy of companies listed on GEM has the premium effect at this stage.The reason may be that diversification can help companies listed on GEM resist externaloperational risks, reduce the competitive pressures and achieve the sharing of resources. Andcompanies listed on GEM also can take advantage of the completion of the efficientallocation of resources in the internal capital market within the enterprise, breaking thebottleneck of external capital market financing restrictions. So the companies can create newvalue and achieve the diversify premium effect of ‘1plus1is greater than2’.4. Adopt the intermediary inspection method to explore the intermediary role of thediversification strategy. The empirical results show that the role of diversification strategy inthe different corporate governance dimension is different. Diversification strategy plays anintermediary role in the proportion of tradable shares-financial performance. Diversificationstrategy plays an intermediary role in the shares held by senior executives-financialperformance. Diversification strategy plays an intermediary role in the executiveremuneration-financial performance. The proportion of tradable shares, shares held bysenior executives and executive remuneration have a direct impact on corporate financialperformance, but also have an indirectly impact on corporate financial performance throughthe diversification strategy. The intermediary role of diversification strategy plays in othercorporate governance dimensions did not pass the test.The innovations of this paper are mainly the following:First, innovatively building integrated relationship model of corporate governance,diversification strategy and financial performance, and analyze and validate the the modelfrom a theoretical and empirical perspective. Prior scholars either study the relationshipbetween few dimensions of corporate governance to corporate financial performance, or therelationship between diversification strategy and corporate financial performance. Fewpeople do the comprehensive study of the combined effects of the three. This paper sorts outthe relationship among corporate governance, diversification strategy and financialperformance. It is very necessary to the companies listed on GEM of rapid growth in thecritical period. And it’s also enriched the theoretical aspects of the research greatly. Second, the dimensions of the corporate governance division are more comprehensivein this study. Prior scholars divided the corporate governance into three dimensions ofownership structure, board governance, managerial incentives, based on the meaning ofcorporate governance, which has a certain sidedness. We define stakeholder governancecombined with the development status of the companies listed on GEM, based on theprincipal-agent theory and stakeholder theory in this study. Stakeholder governance isdivided into institutional investors, staff, governance and creditor and was quantified. Add itto the research model and involved in statistical analysis. And study its relationship withother variables.Third, add a research focus-the function of the board structure dimension to boardgovernance. Most prior scholars study board governance only from the board size, theproportion of independent directors and the unity of chairman and general manager. Theyignore the important role of the function of the board background. In this paper, we add thefunction of the board structure dimension into board governance combined with the actualsituation of the companies listed on GEM. So the role of board governance variable is morecomprehensive. The study is more consistent with the theoretical and practical requirements.The conclusions are more objective and true. Further enrich the theory of corporategovernance.Fourth, this study is the first to explore the intermediary role of the diversificationstrategy in corporate governance and financial performance. In recent years, many scholarsexplore the mechanism of the role of corporate governance on enterprise performancethrough empirical research. But so far they have not get consistent conclusions. So that thethe relationship between corporate governance and corporate performance is known as a‘black box’ for study (Collins and Clark,2003). This paper discusses the role ofdiversification strategy between corporate governance and corporate financial performancefrom the perspective of the intermediary role of diversification strategy innovatively andprovides further theoretical support to open the ‘black box’.Fifth, the selection of research object focuses on companies listed on GEM to study onthe regularity of development and growth of companies listed on GEM. There areconsiderable differences between the corporate governance in developed and developingcountries, so the empirical test on the data of companies listed on GEM in China is important.In this paper, we are the first to do the systematic and in-depth study of companies listed onGEM and sum up the relevant regularity of the GEM listed companies. It has certainsignificance to the formulation of government policy, the development of GEM market, thegrowth of companies listed on GEM and decision-making of investor.Sixth, enrich the understanding of the effects of diversification strategy of SMEs.Traditional concepts tend to think that the diversification strategy are the patent of largeenterprises, SMEs should not adopt diversification strategy. Diversification of SMEs will bring a reduction of the corporate performance. The results of this study shows that thediversification strategy of companies listed on GEM can enhance the company’s financialperformance in this stage. Whether the SMEs should carry out diversification strategy or notis not absolute. Corporate governance should take full account of the internal and externalenvironment changes, combined with their own development needs, and to seek the beststrategies suitable to grow their own to improve the financial performance of enterprises.