3.

0 Hypothesis Section

The hypothesis in this study is related to the role of majority shareholders in affecting the value
of a firm. The hypothesis suggests that the majority shareholders manipulate the minority
shareholders deteriorating the value of the firm in this financial market.

In the literature review the stewardship and agency theory is discussed. The stewardship theory
states that the majority shareholders as an external monitor improve the value of a firm by
making the democratic decisions (decisions related to defending the rights of the shareholders)
(Kalpan and Minton, 1994). Also the majority shareholders remove the under performing
management in the developing market reducing the agency cost. Yafeh and Yosha (1995)
support the same results and endorse that external corporate governance instrument (majority
shareholders) discipline the internal corporate governance instrument (board) by disciplining the
underperforming directors and reducing the agency cost from the board.

As the external regime (regulatory authority and judiciary) is weak in the developing market, so
there is higher role of majority shareholders to protect the interests of the minority shareholders
(Black, 2001; Ahunwan, 2003). The majority shareholders can improve the shareholders value
by limiting the illegitimate activities of the managers in the developing markets (tunelling)
(Franks and Mayers, 1994). This action will improve the firms performance in the developing
market as the shareholders rights are protected because of equal treatment provided to them in
the financial market.

On the contrary, Pinkowitz, Stulz and Williamsons (2003) argued that majority shareholders
exploit the minority shareholders and deteriorate the shareholders value in the developing
markets. The minority shareholders are also not allowed to use their votes to remove under
performing management. Also, the regulatory authorities do not reduce the gap of information
asymmetry between the principal (shareholders) and the agent (managers).

The agency cost in the firms of the financial market is not decreased as the free hand of the
managers is not reduced from the market. The managers of the firm of developing market are
involved under investment and over investment of the free cash flow (Bebchuk, Cohen, and
Ferrell, 2004). The under investment occurs when the managers do not invest in the healthy
projects as they do not like to share the returns of these projects with the creditors. The other
phenomenon (over investment) of the free cash flow occurs when the managers do not pay
dividend to the shareholders and deteriorate the value of a firm by investing in the projects from
which they can derive some private benefits (Colombo and Stanca, 2006). These projects (having
related private benefits) only benefit the majority shareholders harming the rights of all other
stakeholders in the market.

In addition to the poor role of the regulatory authority the judiciary in the developing market is
also corrupt and biased. The judges do not have proper qualification and have illegal connections
with the politicians and government officials. Also the government in the developing financial
markets neither finances the court optimally nor provides judges and with proper libraries,
guidance session and requisite infrastructure. The lack of these facilities makes the decision
making system in courts slow and irritating. Also, there are additional factors in developing
markets which include non-existence of financial markets, market imperfections, less
sophisticated contracting system, inflation, political instability, lack of transparency in the
market and inconsistent accounting standards, poorly regulated banking system and lower level
of literacy in this market (Pereiro, 2002; Hofstede and Hofstede, 2004). The shareholding is
concentrated and the regulatory framework is weak. The relationship in this market is based on
trust and related ethical norms, which also add to the imperfections in the contracting system
making the financial system more risky (Nam and Nam, 2004; Vives, 2000; Dallas, 2004).

Due to above mentioned imperfections, the shareholders in the developing market pay higher
level of monitoring cost (cost incurred in monitoring the management) residual cost (cost related
to appointing the independent board) and finally the bonding cost (cost related to the operations
of the independent auditor) (Matos, 2001). These costs diminish the value of the shareholders in
the developing market. The additional imperfections also affect the majority shareholders and the
value of a firm relationship and we expect a negative relationship between the shareholders value
and the presence of blockholders in the developing market.

The second variable used in the study is the size of board. The variable is used to test the
relationship of board size with the value of a firm. A positive relationship between the bigger
board and the value of a firm is expected in this study.
Board is an important corporate governance instrument in affecting the value of a firm
(Nikomborirak, 2001). Board performs important regulatory duties such as keeping an eye on the
management of the firm and providing accurate financial information to the investors. The board
members should not harm the rights of the shareholders and deteriorate their value (Tomasic,
Pentony and Bottomley, 2003). The board consists of two types of directors; outsider and insider
one. The outsider directors are also called as independent directors. These directors are not the
employees of the firm and can monitor the operations of the firm on the independent basis
reducing the agency cost from the market (Bhagat and Black 2002). On the contrary, Bhagat and
Jefferis (2002) argued that the outsider (independent) directors do not improve the value of a
firm as they do not have any financial interest related to the firms performance.

Similar to the role of outsider directors, the insider directors also constitute the board. These
directors work for the organization and represent the interest of all other employees of the firm.
The insider directors control higher level of financial information and can force the management
to make democratic decisions (Nam and Nam, 2004). The internal directors can reduce the
information asymmetry by giving equal information to both minority and majority shareholders.

As we have discussed the role of the combination of board, the size of the board is also an
important determinant to improve the value of a firm. There are two theories about the role of
board size in affecting the value of a firm. These theories include stewardship and agency theory.
The stewardship theory suggests that bigger board improves the value of a firm in the financial
markets as the board members have higher level of strategic, planning and conceptual expertise.
These skills improve the decision-making systems in the firm. Furthermore, the bigger board can
resist the autocratic and irrational decisions of the CEO as suggested by Zahra and Pearce
(1989). The smaller boards have less level of vision and skills which can enable the CEO to
dominate the board and make irrational decision harming the shareholders value.

The second theory about the relationship of the board size in affecting the value of a firm is
called as agency theory. This theory suggests that the bigger board can make irrational decisions
affecting the shareholders value in the negative manner (Yermack, 1996). The members of the
bigger board are not united which results in the slow and costly decision making process in the
board. There is also a free rider problem in the bigger board when some of the board members do
not perform their duties of monitoring instead they depend on their peer members to improve the
value of a firm (Loderer and Peyer, 2002). There is also communication and coordination
problem in the bigger board which makes it difficult for the board members to remove the under
performing management (Jawell and Reitz, 1981). On the contrary, the smaller board is more
cohesive and can make quick and rational decisions improving the value of a firm.

As discussed before that the board consists of the mix of insider and outsider directors. The
optimal combination of board of directors (insider and outsider) can make the board as an
efficient internal corporate governance instrument and create value in the presence of additional
imperfections and weak external regime. The majority shareholders can affect the size of the
board and encourage the CEO to have an optimal combination of insider and outsider directors.
We argue that majority shareholders play a positive role in maintaining the board size and
optimal combinations of directors in the board.

The third variable used in the study is about the role of leadership structure. The role of
leadership structure is imperative component of corporate governance in the financial market. As
discussed in the literature review, there are two main types of leadership structure which include
dual and non-dual leadership structure (Lam and Lee, 2008). The dual structure of leadership
refers to the structure in which the CEO also holds the position of the chairman of the board. On
the contrary, the non-dual leadership structure refers to the holding of the two positions by the
separate individuals (Brickley, Coles and Jarrell, 1997; Kyereboah-Coleman and Biekpe, 2005).

There are two theories related to the role of dual leadership structure in affecting the firms
performance. The first theory is called as stewardship theory and suggests a positive relationship
of dual leadership structure and the value of a firm. This type of relationship of the CEO duality
and firm performance is supported by Zahra and Pearce (1989). The supporters of this school of
thought (stewardship theory) argue that a single person holding both the important positions is
cost effective. The type of leadership structure also reduces the agency cost from the firm as
there is a lack of divergence of interest between the CEO and the chairman. The theory further
argues that the top management is inclined to work for the benefits of the shareholders. The
managers are self-motivated person and drive strength from non financial benefits. The senior
managers are also concerned about their tenure and remuneration provided to them from the
organization which makes them work for the benefits of the shareholders of the firm (Lam and
Lee, 2008).

The CEO holds an important position to incorporate the corporate governance provisions in the
firm and as the steward can make the firm democratic (Bhagat and Jefferis, 2002). Similarly, the
board is in a position to fix the salary of the CEO in accord to his efforts. The board of directors
can also relate the incentives and bonuses to the CEO with the firms performance. This will
converge the interest of the shareholders (principal) and the CEO (agent) ultimately improving
the value of a firm. On the contrary few researchers support agency theory and argue the single
person holding both the important position is contrary to the corporate governance principles.
This type of leadership structure deteriorates the firm performance as the independent decision
making of the board member is harmed. In the developing financial markets, the majority
shareholders in the presence of dual leadership structure deteriorate the value of a firm as the
performance of CEO is not monitored properly. These CEOs are generally involved in tunneling
(expropriation of minority shareholder) in the financial markets.

In the second type of leadership structure (non dual) the positions of CEO and chairman are held
by two different individuals. This type of structure is consistent to the corporate governance
principles and affect the value of a firm in a positive manner. The value of the shareholders is
created as the independence of the board is not harmed in case of non dual leadership structure
(Weibach, 1988 p. 435). The non dual leadership structure also improves the firms performance
as both the top administrative jobs are performed by specialized persons (Higgs, 2003 p. 23).
Corporate governance principles suggest that the CEO should perform the job of regulating the
operational side of the firm and chairman should chair the board and monitor the performance of
the CEO. One person monitors the operations of the firm and the other controls the activities of
the board and makes the decisions about the remuneration and compensation of the CEO (Nam
and Nam, 2004). The non-dual leadership structure endorses the independence of the board as
the CEO is restrained to dominate the board and to make irrational decisions.

On the negative side, the non-dual leadership structure may deteriorate the firms performance
due to the potential divergence of the interest between the CEO and the chairman. The regulatory
authority in the developing market is weak and do not control the board member and the CEO
deteriorating the value of the shareholders. The additional factors in the developing market also
make these regulatory authorities less effective in controlling the internal corporate governance
instruments (CEO and chairman) and improving the value of a firm.

Similar to the role of regulatory authorities the majority shareholders in the developing financial
markets can force the independent CEO to work for the benefit of all the shareholders and reduce
the amount of private benefits in the market. Also, in case of non dual leadership structure, the
majority shareholders can reduce the level of divergence between the CEO and chairman and
improve the value of a firm. The study will testify this role of majority shareholders in affecting
the leadership structure and the firms performance in the financial markets.

The literature presented before has been summarized in the diagram as follows:

Liquidity

Board Size
Majority Efficient
Shareholder utilization
s Leadership of assets
Structure

Additional Information
Imperfection Efficiency

The conceptual framework shows the role of majority shareholders in affecting the efficiency of
the internal corporate governance instruments (board size and CEO duality). The role of
additional factors affecting this relationship is also depicted. These internal corporate governance
instruments, board size and CEO duality can incorporate the corporate governance provision and
regulate the market. These provisions include information efficiency, market liquidity and
effective utilization of assets in the market.