An Empirical Analysis of the Impact of Corporate Governance Mechanisms on the Performance of UK Firms

Abstract

The agency model provides a number of ways to address the problems raised by the separation of ownership and control in public limited liability companies. In its Code of Best Practice, the Cadbury Committee proposed a variety of monitoring mechanisms which, if implemented, should improve corporate governance. As part of the Code, it was recommended that firms should have adequate non-executive director representation. They should also appoint an audit committee, the primary purpose of which was to monitor the auditing controls of the company. The extent to which these structures influence performance is analysed. In addition, we analyse the structure and calibre of audit committee membership and its effect on the performance of 312 large UK quoted companies. The effectiveness of the market for corporate control is investigated by means of take-over intensity by sector. We find that neither the independence of the committee membership nor the quality of the committee members has an effect on performance. However, we find that take-over intensity is negatively related to performance. This suggests that external control mechanisms are more effective than internal ones. When performance is split into deciles, there is some evidence that non-executive director independence and the market for corporate control are substitute governance mechanisms.

Keywords: Corporate governance; Firm performance; Audit committee; Cadbury Committee; Entrenchment; Board independence; Duality; Market for corporate control; Takeovers; Governance mechanisms

JEL Classification: G32, G34, L21