Is corporate governance effective in Kazakhstan?

Master's Thesis 2013 52 Pages

Business economics - Business Management, Corporate Governance


Table of Contents



Table of Contents


1 Introduction

2 Literature review
2.1 The separation of ownership from control
2.2 The agency theory, market efficiency and management competition
2.3 The role of large shareholders and legal protection
2.4 Empirical research in the Developed and Emerging markets
2.5 Transitional economies
2.6 Summary
2.7 Hypothesis development

3 Methodology
3.1 Research design and data collection
3.2 Variables measurement
3.2.1 CEO turnover
3.2.2 Board size
3.2.3 Independent directors
3.2.4 CEO ownership
3.2.5 Performance measures
3.2.6 Firm size
3.2.7 Firm leverage
3.2.8 Model Specification
3.2.9 Summary

4 Results and Discussion
4.1 Descriptive statistics
4.2 Regression results
4.3 Limitations

5 Conclusions and recommendations

6 Personal learning and development

7 The list of references

8 Appendices


Table 1. Descriptive summary

Table 2. Descriptive summary. Items grouped by year

Table 3. Descriptive summary. Items grouped by CEO turnover occurrence

Table 4. Regression results

Table 5. Stata Do file


The loud corporate failures have seriously shaken the public belief in modern corporate system and challenge the arguments of agency theorists. While modern corporate system in the developed economies has been built for centuries, the issues stemming of separation of ownership and control threaten to be-come considerable for post-transitional countries. This dissertation aims is to assess the effectiveness of corporate governance mechanisms in Kazakhstan. Taking the agency perspective, the assessment is carried out by examining the management turnover – performance relationship in 73 Kazakh firms listed on Kazakhstan Stock Exchange for the period of 2011-2013. The negative association between past performance of firms and management turnover was found significant at borderline line of 5% level, which cannot be interpreted as evidence of strong relationship


I would like to thank Oleksandr Talavera for his guidance and friendly tutorship of my work. I would like to express my special gratitude to Michael Frize. Without their support I would never been able to finish my work.

1 Introduction

The legal form of open stock corporations implies the joint ownership by shareholders. Ownership rights are confirmed by common stocks giving their owners a privilege to vote on sensitive and important decisions. The important features of public ownership include limited liability and free transferability of shares among investors (Britannica, 2013). Given that the amount of stock owners can reach up to ten thousands and the ownership concentration can be widely diffused, the fundamental issue that has been disturbing academics is a free-rider problem. The free-rider problem stems from the fact that none of the shareholders has enough interest to carry out control over managers (Grossman and Hart, 1980). The issues evoked by separation of ownership from control worsen as managers are likely to act not in the best interests of shareholders. This conflict was documented by Adam Smith at least in 1776 (cited in Jensen and Meckling, 1976). From the theoretical perspective, boards, market for corporate control, competition among managers and large shareholders, serve as monitoring mechanisms and help shareholders to discipline incumbent management (Jensen and Fama, 1983; Grossman and Hart, 1980; Fama, 1980; Shleifer and Vishny, 1986). However, loud corporate scandals since 1980 in Anglo-Saxon economies have seriously shaken the public belief in modern corporate system and challenged the arguments of theorists (Edwards, 2003). On a political level, this led to substantial reforms in legislature. In the US, the adoption of Sarbanes-Oxley Act in 2002 was called to reinforce corporate monitoring by strengthening the role of independent directors and auditors (Edwards, 2003). The series of government committee reviews have led to the elaboration of Corporate Governance Code in the United Kingdom. With the same intense, the issues of corporate governance have become a subject of substantial research on academic level. It is recognized by scholars that weak governance mechanisms can lead to managerial entrenchment resulting in expropriation of shareholders and at worst, managers’ incentives to strengthen themselves and avoid disciplining (Shleifer and Vishny, 1996)

While modern corporate system in the developed economies has been built for centuries, the issues stemming of separation of ownership and control threaten to become considerable for post-transitional countries. The Republic of Kazakhstan has begun its post-socialist history as a market economy in 1991. Apparently it didn’t take long to encounter sizeable corporate failures, which led to default of the 2 largest Kazakh banks in 2009. The former chairman of BTA bank having escaped imprisonment is being accused in fraud in the United Kingdom Supreme Court with claims exceeding 3 billion GB pounds (Milmo, 2012). The former Chairman and Chief executive officer of another bank were sentenced for concealment of over 1 billion US dollars (Gizitdinov, 2012). Meanwhile, addressing concerns of investors, co-chair of the Kazakh-British Trade and Industry Council, John Stuttard, gives a high appraisal to broad corporate governance aspects in the republic (2011).

This dissertation aims is to assess the effectiveness of corporate governance mechanisms in Kazakhstan. As Corporate Governance poses broad research questions, this research takes the agency theory perspective, and follows the definition of corporate governance as ‘the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment’(Shleifer and Vishny, 1996). The assessment is carried out by examining the management turnover – performance relationship in Kazakh stock listed firms. Such approach is based on the premise, that shareholders exercise disciplining by firing managers, which fail to perform well. The negative significant relationship between management turnover and performance implies that monitoring mechanisms work effectively and there are no explicit signs of managerial entrenchment (Weisbach, 1988; Kaplan 1994a, 1994b; Muravyev, Talavera, Bilyk and Grechaniuk, 2010). Though, researchers have achieved a general consensus that the likelihood of management turnover increases with poor performance of firms (Huson, Malatesta, Parrino, 2004), scholars indicate that the number of studied countries remains small (Shleifer and Vishny, 1996, Denis and Mc Connell, 2003). Additional interest is invoked by the fact, that research is conducted over the post-privatization economy.

The data for 73 companies, listed on Kazakhstan Stock Exchange, was collected by exploring corporate documents and financial statements for the period of 2010-2013. The management turnover - performance relationship was estimated by employing the logit regression. Obtained results indicate, that the likelihood of management turnover is negatively related to past performance in Kazakh firms. The evidence is significant, but not strong. The dissertation begins with the broad review of the literature covering background of the problem, the elaboration and development of theories in the studied area and empirical research. Hypothesis development is followed by the research design, determination of variables and model specification. Chapter 4 presents description of data, discussion of obtained results and limitations of the model. Final chapter draws conclusions and gives recommendations for future research.

2 Literature review

2.1 The separation of ownership from control

‘The directors of such [joint-stock] companies, however being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which a partners in private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.’

The classical divergence of interests between managers and owners has been sharply remarked by Adam Smith in 1776(cited in Jensen and Meckling, 1976). At the beginning of the 20th century this statement has received special topicality in the influential book of Berle and Means (1932). Academics report a large dispersion of stocks among shareholders in the largest US corporations. According to authors, the largest equity holder among 14 major US enterprises in 1929 owned 2.74% of shares from the total number of 23 738 stockholders (Berle and Means, 1932, ch.4). Being so widely diffused, none of the shareholders was able to dominate and had no interest to exercise his power over managers (Berle and Means, 1932, ch.5). Their conclusion is that stock companies in their evolution witnessed “separation of ownership from control”; the shareholder delegated wealth to corporations which have been controlled by the groups of executives (Berle and Means, 1932, ch.1):

“…In its new aspect the corporation is a means whereby the wealth of innumerable individuals has been concentrated into huge aggregates and whereby control over this wealth has been surrendered to a unified direction. The power attendant upon such concentration has brought forth princes of industry, whose position in the community is yet to be defined...”

Discussing the negative consequences of such process, Berle and Means (1932, Ch. 6) warned that the outcome could be burdened with divergence of interests among those groups owning and controlling corporations:

“…We must conclude that the interests of control are different from and often radically opposed to those of ownership; that the owners most emphatically will not be served by a profit seeking controlling group…”

The disturbing message of Berle and Means (1932) was that the fundamental basis of private property has been undermined (O’Kelley, 2010). The following generation of researchers has been trying to solve the puzzles posed by authors.

2.2 The agency theory, market efficiency and management competition

From a historical perspective the issues posed by Berle and Means (1932) have been addressed by the agency theory (Jensen and Meckling, 1976). In 60s and early 70s, the agency theory was concerned with research of risk sharing among individuals (Eisenhardt, 1980). The core notion of the agency is formulated by Ross (1973). He posits agency relationships as relations between principals and agents with multidirectional interests, where the expected residual return of each party is adjusted for these conflicting goals.

The concept of agency is later advanced by positivist researchers (Eisenhardt, 1980). Jensen and Meckling (1976) define agency relationship as a contract between agent and principal, which have conflicting goals and this conflict causes the agency costs. According to authors, agency costs are the sum of the monitoring, bonding and residual costs (Jensen and Meckling, 1976). A principal in order to secure himself from the opportunistic behaviour of an agent incurs monitoring costs and provides compensation. The agent on his part bears bonding costs to guarantee his loyalty to the principal. The additional detriment suffered from remaining divergence in interests is residual loss. Agency theorists make recourse to the property rights concept and apply the theory in respect to private corporations (Jensen and Meckling, 1976). They explain how managerial incentives cause the agency problems in different combinations of stock ownership and in the presence of debts. Scholars argue that when the corporation is fully owned by an entrepreneur, there are no agency costs because the firm is ran by its owner and he bears all the costs of his perquisites (Jensen and Meckling, 1976). The additional increase in entrepreneurial efforts leads to maximization of his wealth and is entirely enjoyed by the manager. But as firm raises external equity capital the costs of managerial perks are shared by manager and the external stockholders. The entrepreneurial efforts of the manager will be limited to the wealth that is generated by the fractions of his stocks in the total equity of the firm. The raise of capital from the debts market creates managerial incentives to engage in risky projects because debt holders have senior claims in respect to shareholders. Hence they bear major part of risks. But opposed to the debt holders, the shareholders have the claim on the major part of earnings of such risky projects since the returns of the latter are fixed (Jensen and Meckling, 1976). In the view of agency theorists, conflicting goals between equity holders and managers can be aligned by complete contracts, written or unwritten (Jensen and Meckling, 1976). However in reality complete contracts are costly because they would have to be specified for all possible outcomes and legal consequences (Hart 1995).

In respect to organizational theory, the fundamental and far-reaching assumption of the agency theory is a view of a firm as a nexus of contracts -“a set of contracting relationships among individuals.” (Jensen and Meckling, 1976). The contractual perspective leads to understanding a firm as relationships of risk-averse agents pooling resources and establishing contracts motivated by value maximizing and cost minimizing behaviour (Jensen, 1983b; Fama, 1980). An elaboration of corporations into large enterprises with widely diluted equity ownership, agency theorists explain from an evolutionary perspective of effective risk sharing and capital allocation. In firms, demanding considerable amount of capital, the larger risks of future cash flow streams are effectively allocated among vast number of shareholders (Jensen and Fama, 1983). According to authors, the need for efficient allocation of capital and risk diversification has led to elaboration of Stock exchanges. The supervising function has been delegated to talented managers. Jensen and Fama (1983) argue that organizations, forced by a competitive environment, have been able to survive because equity owners have successfully dealt with the agency problems assisted by market efficiency mechanisms. As decision making function is given to managers, monitoring functions are fulfilled by expert boards. In open stock corporations these monitoring functions are delegated to boards of directors, and in particular, the important monitoring function is fulfilled by outsider directors (Jensen and Fama, 1983). Market efficiency assists by reflecting the agency costs in the prices of stocks. If agency costs offset and exceed expected benefits, investors recognize this which leads to the price decrease by the amount of agency costs borne by shareholders (Jensen and Meckling, 1983). Further, firms with low market value become an easy target for hostile raiders who exploit the opportunity to take control over the firms and fire badly performing managers (Manne, 1965). Fama (1980) suggests that another disciplining mechanism is external managerial labour market and internal competition among managers which put pressure and scrutiny on top managers.

Thus, theories suggest that boards, potential susceptibility to takeovers and managerial competition serve as disciplining and monitoring mechanisms restricting managerial shirking.

2.3 The role of large shareholders and legal protection

The key notions of the agency theory have laid theoretical foundations to Corporate Governance. Following the agency perspective, Shleifer and Vishny (1996) define Corporate Governance as: “the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.” Scholars show that large shareholders have interest to exercise disciplining functions unlike minority investors thus providing another solution to agency problems (Shleifer and Vishny, 1986). Shleifer and Vishny (1996) argue that large shareholder and legal protection are the essential elements underlying the effectiveness of governance mechanisms. Authors explain that strengths of legislature predetermine the development of markets to concentrated or diffused ownership patterns across the world (Shleifer and Vishny, 1996). Countries which have less friendly laws for minority shareholders are likely to witness large shareholders among equity owners because it would be the most efficient way to control management decisions (Shleifer and Vishny, 1996).

The weak system of governance mechanisms may lead to substantial agency costs borne by shareholders and non-value maximizing behaviour of executives (Shleifer and Vishny, 1996; Morck, Shleifer and Vishny, 1988). For example, managers may establish unfavourable business relationships with companies they own thus carrying away wealth from shareholders (Shleifer and Vishny, 1986). In other cases, managers may secure themselves from firing by investing in projects demanding specific knowledge, even if those projects do not bring value to shareholders (Shleifer and Vishny, 1989).

Following this context, the Corporate Governance has received the criterion of effectiveness in terms of ability of monitoring mechanisms to recognize and discipline shirking managers (Weisbach, 1988; Kaplan 1994a, 1994b; Muravyev et al, 2010). Theoretical hypotheses of monitoring mechanisms have become a subject to considerable body of empirical studies.

2.4 Empirical research in the Developed and Emerging markets

Coughlan and Schmidt (1985) and Warner, Watts and Wruck (1988) are among pioneers in this area. Coughlan and Schmidt (1985) examined whether monitoring mechanisms incentivize managers for positive abnormal stock returns and discipline in cases of poor stock performance. They obtained data for 249 companies from Forbes Magazine for 1978-1980 time periods. To check whether there was a relationship between compensation and performance they regressed real rate of change in pay as independent variable and abnormal stock return lagged for 1 year as dependent. The probability of Chief Executive turnover (CEO) following poor stock performance was estimated using the logit model. They found strong and statistically significant evidence that compensations are positively but management turnover negatively related to past stock performance.

Warner et al (1988) confirm the evidence of disciplining for the period of 1963-1978. They examined whether the information of firms’ performance was reflected in stock market prices and whether it was used to evaluate managers. Researchers obtained data for 269 companies listed on the New York (NYSE) and Amsterdam Stock Exchanges (AMEX). Focusing exclusively on internal governance mechanisms they excluded cases with large transfers of share blocks accompanying management termination to isolate them as an external disciplining mechanism. Researchers distinguished between board turnovers, forced CEO departures, changes reported in Wall Street Journal (WSJ) and turnovers followed by an appointment of an outsider. Board turnovers were defined as changes of CEO, president or Chairman of Board. Forced turnovers were identified if they were reported as “poor” in the Poor’s Register of Corporations, Directors and Executives (Poor’s) and coincided with the reports in WSJ. They found 549 forced changes in Poor’s list and 351 in WSJ. Researchers used 1 year market return of the Centre for Research in Security Prices (CRSP) index and company stock returns for current year, lagged for 2 and 3 preceding years as performance measures. Scholars isolated each type of turnover variable by running 4 regressions. The current year stock returns were statistically significant in each case. Additional model with independent firm size variable indicated statistically significant result which was interpreted as the evidence that larger firms have higher “normal” turnover rates.

Kaplan (1994a) continued studies in US and switched to a later period of 1980-1989. In addition, he examined turnover, compensation and firm performance relationships in Japan to compare the results. The data for 119 Japanese and 146 US companies is taken from the 500 largest industrial Fortune’s list in 1980. In addition to companies’ stocks returns Kaplan (1994a) designs accounting measures – sales growth, ratio of change in EBIT to assets ( ) and a dummy variable for the sign of net income value. Researcher reports that negative performance leads to increase in likelihood of executive turnover, while stock performance has positive effect on compensation (Kaplan, 1994a) Kaplan (1994a) concludes that results are significant and strengths are similar for both countries.

Further, focusing on the same time span and using the similar performance measures, he examined turnover of management board and Chairman of the board in Germany (Kaplan, 1994b). The data on 61 companies is obtained from the 500 largest foreign industrials’ list in Fortune Magazine. Companies with foreign shareholders owning more than 90% of equity were excluded. The regression yields statistically significant relationship between management board turnover and past stock performance, but coefficient is not significant for the chairman of board (Kaplan, 1994b). At same time, the coefficient of chairman turnover increases significantly if there was a loss in net income. Kaplan (1994b) reports that strength of turnover rates in Germany do not vary substantially comparing to US and Japan.

Mikkelson and Partch (1997) compared managerial disciplining rates between periods of active takeovers occurred during 1984-1988 and period of low takeover activity in 1989-1993. The data was extracted from CRSP and Compustat databases for 227 companies for the earlier period and 218 companies for the second period. Management turnovers were defined as changes of three highest officers – CEO, Chairman of the Board and President. Voluntary changes were not isolated; however the estimation was controlled for CEO age. The designed performance measures - stock return and ratio of operating income to assets were adjusted to industry and size. Other control variables included book value of the firms’ assets, total liabilities to assets ratio, board size, proportion of outside directors, and CEO’s stakes. The two periods were controlled by the dummy variable and interaction variables to capture periodical sensitivity of turnover to performance. The logit model indicated statistically significant results for dummy variables suggesting that turnover rates in active market period are sensitive to past performance, but insignificant for less active takeover market. Researchers report that the relationship of management turnover to past performance disappeared in the period of less active takeover market (Mikkelson and Partch, 1997).

Gibson (2003) extended studies by bringing evidence from Brazil, Chile, India, Korea, Malaysia, Mexico, Taiwan and Thailand. The data was obtained from Wordlscope for the period from 1993 to 1997 and was pooled to a single sample. Forced turnovers were not isolated from voluntary because of unavailability of that information. Researcher estimated logit regression of turnover dummies with stock market return, sales growth, earnings to assets ratio (EBIT/Assets) and Earnings/Assets (Gibson, 2003). The accounting measures’ coefficients are statistically significant at 5% except for stock market return with p>0.059. Gibson (2003) assumes that border insignificance of market return is caused by relative inefficiency and illiquidity of stock markets in emerging markets. Overall, results were robust and the model passed the goodness-of-fit tests. Further, Gibson (2003) compared the coefficients with results for US obtained by Kaplan (1994a). The strengths of results are similar in emerging markets and in US except for past stock market return (Gibson, 2003). In addition, Gibson (2003) examined how the presence of large shareholder owning at least 20% of equity affected the CEO turnover-performance relationship. He reports managers in firms with large shareholders experience less disciplining which suggests that large shareholder may protect managers from outside pressure to pursue their own interest (Gibson, 2003).

Huson et al (2004) suggest that another quality indicator of governance mechanisms is election of managers who improve post performance of the firms. They used limited maximum likelihood method to examine how performance affects CEO turnover and how it changes following the new appointment. Researchers obtained data for all listed companies in Forbes compensation survey for the period of 1971-1995. As Warner et al (1988), they isolated CEO turnovers if there was a takeover in the preceding year. Turnovers were classified as forced in accordance with WSJ reports and if CEO is under the age of 60. Researchers used accounting measures - industry adjusted returns on sales (o ROS) and returns on assets (o ROA) with operating income in the numerator (Huson et al, 2004). They report statistically significant results for turnover rates following poor performance and post improvement of group-adjusted performance measures and interpret results as the evidence of increase in quality of newly appointed managers (Huson et al, 2004).

Weisbach (1988) finds that outsider dominated boards have a higher positive correlation with management turnovers than insider dominated boards. He examined data from Forbes Magazine and CRSP. The final sample included 322 company listed on NYSE for the period of 1977-1980. CEO dismissals due to death, health problems and retirement were controlled with dummy variables. Other control variables included CEO ownership. Weisbach (1988) finds a significant negative relationship between CEO turnover and outsider dominated boards. He suggests that this relationship may be influenced by a third factor for instance CEO strength (Weisbach, 1988). Researcher assumes that strong CEOs would form the board with loyal insiders, hence weak CEOs were more likely to have outsider dominated boards and experience disciplinary actions (Weisbach, 1988).

Similar to Weisbach (1988), Borokhovich, Parrino and Trapani (1996) report significant relationship for 969 successions in 588 largest companies for the period of 1970-1988. Probit model used in regression yielded strong evidence that outsider dominated boards increase the likelihood of CEO turnover. In addition they find, that outsider dominated boards are likely to hire new CEO from outside rather than it will be an inside succession (Borokhovich et al, 1996).

Bhagat and Bolton (2009) confirm these results for the 1998-2007 periods. They were particularly interested how the role of independent of directors changed after the adoption of Sarbanes Oxley Act (SOX) in 2002. Researchers divided a sample of 1951 successions in pre-2002 data and post periods. They employed multinomial logit regression and controlled estimation for voluntary turnovers. As performance measures they designed two year lagged company and industry adjusted stock returns. Other control variables included CEO ownership, age, tenure and firm size. Using interactive variable for proportion of outsiders in board and performance, they find that outsider dominated boards are effective monitors for the whole period (Bhagat and Bolton, 2009). However, researchers state that their main finding is that outsider dominated boards have greater positive impact on firm performance after the adoption of SOX in 2002 (Bhagat and Bolton, 2009).

Yermack (1995) finds that companies with smaller board size perform better and are more likely to fire incumbent managers. He examined data from 500 Fortune’s magazine for largest 452 companies during 1984 to 1991. Tobin’s Q measured as the ratio of market value of assets to replacement cost of assets was employed as dependent variable in ordinary least squares regression. Tobin’s Q was regressed against natural log of board size, current and previous return on assets ratios, proportion of independent directors and control variables. Yermack (1995) finds statistically significant negative relationship between board size and firm value. Further researcher employed probit model to estimate how likelihood of CEO dismissal varied with board size. The regression was controlled for CEO ownership, age and firm size. Interaction of board size yielded significant result at 5% level providing evidence that increase in board size leads to decrease in the likelihood of CEO being fired. In additional analysis, he estimated the effect of independent directors on CEO turnover using the same technique as Weisbach (1988). However, Yermack (2003) reports he doesn’t find similar relationship.

Franks, Mayer and Renneboog (2001) claim that non-executives do not discipline CEOs in the UK. They find that turnover rates significantly increase only with purchases of share blocks and high financial constraints. Data on the composition of the board was compiled for each year from 1988. Practitioners extracted data from Data Stream, the Financial Times Nexus databases and annual reports for the period of 1988 to 1993. Management turnover was measured as the ratio of dismissals to the total board size. Authors isolated forced turnovers and left 243 companies. The performance measures designed were industry adjusted annual abnormal returns, dummy variable when earnings were negative, industry adjusted return on equity (ROE), and a dummy variable if dividends decreased or abolished. The estimation was controlled for takeovers, large transfers of shares and firm size.

Faleye (2003) extended studies by focusing on small companies. From a data of Securities and Exchange Commission he isolated companies where CEOs were appointed in 1994-1995 and dismissed until 2001. Management resignations due to death and health problems were excluded from observations. By employing a proportional hazard model Faleye (2003) estimated the probability of CEO turnover following after performance deterioration and examined whether turnover rates varied with the board size. Faleye (2003) reports the likelihood of management turnover increases with poor performance. As well as Yermack (2003), Faleye (2003) finds the coefficient of board size to be significant at 1% level suggesting that increase in boards reduces the likelihood of CEO dismissal.

Chakraborty and Seikh (2008) confirm these results for 137 management changes during 1994-1999. The data was taken from Standard and Poor’s Execu Comp 2000 dataset. They identified and sorted out forced turnovers. Performance measures chosen were ROA, change in ROA, 1-year stock return and 3-year stock returns. The estimation was controlled for firm size, age of CEO, year and industry dummies. By estimating the regression with logit model, Chakraborty and Seikh (2008) report statistically significant negative relationship between firm performance and the likelihood of CEO turnover. In addition, CEO ownership and board size significantly decreased the likelihood of management turnover (Chakraborty and Seikh, 2008).

2.5 Transitional economies

Fidrmuc and Fidrmuc (2007) examined 917 Czech non-financial firms during the post privatization period of 1993-1997 using a panel data. The panel data was unbalanced because of unavailability of financial data for several firms at the beginning of the period. These observations were excluded. For the same reason researchers were not able to isolate forced turnovers from voluntary. The performance was measured by labour productivity, gross profit margin per employee and ROA by labour. The estimation was controlled for firm size. Researchers report that they don’t find evidence of management turnover association with past performance of firms for the whole period; however performance coefficient becomes significant starting from 1997. Fidrmuc and Fidrmuc (2007) interpret results as positive effect of privatization on corporate governance because significance of management turnover coefficient in the later period was the evidence that new owners start to exercise disciplining.

Lau, Fan, Young and Wu (2007) examined whether the corporate governance is effective in China. They extracted data for 496 companies listed on Shenzhen and Shanghai Stock Exchanges since 1996 and tracked dismissals till 2003. Lau et al (2007) employed a logit model using lagged return on assets (ROA) as performance measure. The estimation was controlled for firm size, retirement age, industry size, board size and proportion of independent directors. To test the whether outsider dominated boards increase likelihood of managerial turnover they designed interaction variables. Final results yielded statistically significant negative relationship between past performance and turnover. Researchers report that the coefficient for the proportion of independent directors is positive and significant but the interaction variables are meaningless.

Muravyev et al (2010) extended the number of explored transition economies. They examined a sample of 916 Ukrainian companies from a National Stock Database for the period of 2002-2006. Researchers employed a logit model to estimate the probability of management turnover following poor performance with a set of determinants such as Board size, Managerial ownership, leverage, liquidity, CEOs’ age and a dummy variable indicating managers’ gender. The estimation was controlled for firm size measured as natural log of assets and labor productivity, industry and region. Lagged return on sales (ROS) and ROA were used to capture performance. They employed interaction variables of performance with management shareholdings, size of the boards and industry affiliation. The regression yielded strong statistically significant results for performance-turnover relationship. Researchers report that managerial ownership reduces the likelihood of turnover financial and financial constraints positively affect turnover rates (Muravyev et al, 2010)

The research of corporate governance in Kazakhstan and in Central Asia is limited. The post-Soviet history of Kazakhstan begins with two staged privatization process in 1991 and 1993 resulting in partial transfers of state owned enterprises predominantly to employees and managers (Jermakowicz et al, 1996). Troschke and Zeitler (2006) compared privatization outcomes and agency problems in Kazakhstan and its closest neighbor Uzbekistan. Researchers conducted a survey among 31 Kazakh food companies and 77 Uzbek firms in food and light industries. Troschke and Zeitler (2006) report that all surveyed Kazakh companies except 3 were totally privatized in Kazakhstan until 2003. In accordance with results, they state that don’t find appropriate use of incentive components in managerial contracts in both countries (Troschke and Zeitler, 2006). According to the survey results, managers of 38% of Kazakh companies report that monitor their compliance themselves and only 16% indicate that monitoring is held by boards of directors (Troschke and Zeitler, 2006).

2.6 Summary

Berle and Means (1932) report large diffusion of stocks among shareholders at beginning of 20th century. Scholars conclude that this leads to the separation of ownership from control in modern corporations and raise the issues of divergence of interests between managers and shareholders (Berle and Means, 1932). Agency theorists view the firm as a set of contracts among different agents (Jensen and Meckling, 1976). These agents have conflicting goals and are motivated by value maximizing and cost minimizing behavior (Jensen, 1983b, Fama, 1980). The Divergence in interests among agents causes the agency costs which are the sum of monitoring, bonding and residual losses (Jensen and Meckling, 1976). To reduce the agency costs, principals implement monitoring of agents by delegating decision control functions to boards (Jensen and Fama, 1983). Managerial shirking is recognized by investors which his leads to the discount of stock prices. Hostile raiders exploit this opportunity; buy out the blocking ownership and fire managers (Manne, 1965). Thus takeovers play another monitoring function. Another disciplining mechanism is competition among managers. Lower level and outside managers monitor incumbent CEOs and scrutinize their performance (Fama, 1980). Jensen and Fama (1983) addressing the issues posed by Berle and Means (1932) argue, that if monitoring was ineffective due to separation of ownership from control, corporations wouldn’t have survived and elaborated in their modern form. Recent research in Corporate Governance has extended and developed the ideas of agency theorists. Shleifer and Vishny (1996) argue that in the presence of concentrated ownership, large shareholders perform disciplining functions. Various ownership patterns across the world, authors explain from the perspective of legal protection of investors. (Shleifer and Vishny, 1996). Thus, authors consider large shareholders and legal protection essential elements of corporate governance effectiveness (Shleifer and Vishny, 1986). The absence of strong governance mechanisms may lead to substantial agency costs and managerial entrenchment (Shleifer and Vishny, 1996; Morck, Shleifer and Vishny, 1988). In this context, empirical research was based on studying CEO turnover – past performance relationship. Negative past performance – management turnover relationship implies that governance mechanisms effectively discipline poorly performing managers (Weisbach, 1988; Kaplan 1994a, 1994b; Muravyev et al, 2010).

Coughlan and Schmidt (1985) find that management turnover increases with poor stock performance, but compensations re positively related to stock returns in 249 companies during 1978-1980. Warner et al (1988) confirm the evidence of disciplining for the period of 1963-1978 focusing exclusively on internal governance mechanisms. Their additional finding is that turnover rates increase with firm size (Warner et al, 1988). Kaplan (1994a) confirms prior finding and reports that turnover rates do not vary substantially in US and Japan during the period of 1980-1989. Further, he finds similar negative relationship between management turnover and past performance in Germany (Kaplan, 1994b). Mikkelson and Partch (1997) report that turnover rates in active market period of 1984-1988 are sensitive to past performance, but don’t confirm these results for less active period of takeover during 1989-1993. Gibson (2003) finds similar negative relationship between performance and CEO turnover in 8 emerging countries. Huson et al (2004) confirms prior finding and reports that performance increases after management dismissals. Weisbach (1988) finds that changes of poorly performing managers are higher in outsider dominated boards in US during 1977-1980. Borockovich et al (1996) echoe this finding and report that outsider boards are likely to hire managers from outside. Bhagat and Bolton (2009) obtain similar results for outsider dominated boards and argue that after the adoption of SOX in 2002 outsider dominated boards have positive impact on firm performance. However Franks et al (2001) don’t find that non-executives discipline CEOs in the UK. They report that turnover rates increase only with purchases of share blocks and positively related to leverage. Yermack (1995) reports that companies with smaller board size perform better and are more likely to fire incumbent managers. However he doesn’t confirm that outsider dominated boards increase turnover rates during 1984-1991 (Yermack, 1995). Faleye (2003) confirms that the likelihood of management turnover increases with poor performance and reports that board size is negatively related to management turnover. Chakraborty and Seikh (2008) find similar relationship for board size. In addition they report that CEO ownership is negatively related to turnover (Chakraborty and Seikh, 2008). Negative relationship between CEO turnover and performance is confirmed by Fidrmuc and Fidrmuc (2007) in Czech after 1997. Lau et al (2010) confirm finding of turnover in China and also find that number of non-executive director positively affects management dismissals.

Evidence from Ukraine is brought by Muravyev et al (2010). Researchers report that management turnover is negatively related to firm performance and CEO ownership, but positively to financial constraints of firms (Muravyev et al, 2010). The research of corporate governance in Kazakhstan and Central Asia is limited. The post-Soviet history of Kazakhstan begins with two staged privatization process in 1991 and 1993 resulting in partial transfers of state owned enterprises predominantly to employees and managers (Jermakowicz et al, 1996). Troschke and Zeitler (2006) conduct a survey among 31 Kazakh companies. Based on the survey results they report that don’t find appropriate use of incentive components in managerial contracts (Troschke and Zeitler, 2006). Managers of 38% of Kazakh companies respond that monitor their compliance themselves and only 16% indicate that monitoring is held by boards of directors (Troschke and Zeitler, 2006).

2.7 Hypothesis development

The overwhelming evidence suggests that governance mechanisms discipline poorly performing managers in transitory markets as well as in developed and emerging economies. Kaplan (1994a) and Kaplan (1994b) show that managers are dismissed in US, Germany and Japan and turnover rates do not to very substantially. Gibson (2001) confirms corporate governance effectiveness in 8 emerging economies. Lau et al (2007) report that the likelihood of management turnover increases significantly with poor performance in China. The evidence of effective corporate governance is reported by Muravyev et al (2010) in Ukraine. Are managers disciplined in Kazakhstan? The evidence of agency problems on the micro level, reported by Troshke and Zeitler (2006) is to some extent limited because of interpretive approach used in their study. It could be argued that self-monitoring perquisite of managers may be based on their beliefs. In addition, generalizations of their findings based on a relatively small number of companies could be questioned accounting for 1500 companies with dispersed ownership to time (OECD report, 2004).

Unlike the developed economies, where the effective monitoring mechanisms have been built over centuries, transitional economies have faced challenging task to construct effective governance system in short period of time. From this perspective evidence from Ukraine (Muravyev et al, 2010), Czech (Formic and Formic, 2007) and China (Lau et al, 2007) may be considered as certain success in transitional economies in establishing appropriate legal protection of shareholders and development of equity markets.

Shleifer and Vishny (1986) emphasize the role of legal protection of shareholders as one of the essential elements of effective corporate governance. In this regard, Kazakhstan has accomplished wide range of reforms (Rayskhanova, 2000). The Kazakh Corporate Governance Code was adopted in 2005 and is based on OECD principles (Johannesson et al, 2012). The Code recognizes necessity of protection of rights and interests of shareholders and the accountability of the board members (Code on Corporate Governance, 2007, ch. 1.1.a). The advisory instructions of the Code leave the legislative priority to the Company Law (Code on Corporate Governance, 2007). The Company law prescribes shareholders as a supreme governing body (Kazakhstan Company Law, 2003, art 33.1). The board of directors is elected by and accountable to shareholders (Company Law, 2003). According to Kazakhstan Company Law (2003) the board may establish a single executive body or collegial. One of the important provisions restricts managers of alienation and acquisition decisions to less than 25% of the firm’s value. Transactions exceeding this amount are controlled by the board of directors (Kazakhstan Company Law, 2003). Effective functioning of takeovers as governance mechanisms supposes the absence of restrictions for investors to alienate from their shares (Jensen and Fama, 1980). The provisions of Company Law (2003, art. 25.1) do not restrict shareholders to freely alienate equity holdings by any amounts thus providing free circulations on the equity market. The government of Kazakhstan has established stock exchange institute for boosting market development and free circulation of equity in 1996 (Rayskhanova, 2000).

Thus, it could be ascertained that Kazakhstan has basic preconditions for effective functioning of governance mechanisms. The Kazakhstan legislature provides boards with necessary provisions to control managers and does not restrict them in disciplining functions in case of unsatisfactory performance. Investors are not restricted to freely exchange stocks and have necessary institutions assisting in these activities which in turn, facilitate takeovers as disciplining mechanism. An evidence of this would be the observation of management dismissals in the presence of poor performance of firms (Coughlan and Schmidt, 1985; Gibson, 2003; Muravyev et al., 2010). Following this reasoning the hypothesis tested is:

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In Kazakhstan, the likelihood of management turnover is negatively related to firm performance.



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kazakhstan KASE corporate governance management turnover kz kaz



Title: Is corporate governance effective in Kazakhstan?