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Board of directors’ effects on financial distress evidenceof family owned businesses in Lebanon

Charbel C. Salloum & Nehme M. Azoury &

Tarek M. Azzi

# Springer Science+Business Media, LLC 2011

Abstract The objective of this paper is to determine the managerial governancecharacteristics related to financial distress companies. The boards failed toaccomplish their monitoring duties, which seemed to be one of the main reasonsbehind the actual financial distress and bankruptcy that swept the companies acrossthe planet. Through the analysis of a sample of 178 Lebanese non listed and ownedfamily firms, the results showed that the boards (that have a higher proportion ofoutside directors) are less inclined to face a financial distress than the boards with alower proportion. Besides, a different conclusion proves that the board’s size andfinancial distress are directly linked. The paper highlights the extent to whichfinancial distress is associated with corporate governance from a Euro Mediterraneancountry. It would be a source of education to Lebanese investors who excessively gofor short-term returns and of help for regulatory authorities in the framework ofmaking policies on corporate governance reformation.

Keywords Financial distress . Corporate governance . Board of directors andbankruptcy

Introduction

Following the world financial scandal of corporate giants, the boards of directorshave been accused of not doing their jobs in a proper and efficient way. That’s whythe corporate governance reforms were established, in order to improve the corporate

C. C. Salloum (*) : N. M. Azoury : T. M. AzziFaculty of Business Administration, Holy Spirit University of Kaslik, Kaslik, Lebanone-mail: [email protected]

N. M. Azourye-mail: [email protected]

T. M. Azzie-mail: [email protected]

Int Entrep Manag J (2013) 9:59–DOI 10.1007/s11365-01 -02 9-

751 0 9

Published online: 22 October 2011

board’s performance (Salloum and Azoury 2009). During the political crisis thatravaged the Middle East between 2004 and 2010, several Lebanese non-listed firmsthat supposedly used over-leveraging and over-investment were subject to financialdistress. The market manipulations led these firms to establish wholly ownedsubsidiaries in order to buy equities from family’s corporate. Besides, the shareholderspledged their assets to financial institutions with a view to raise the funds needed forthis operation. Afterwards, they would take hold of the capital gains in case thepolitical crisis is resolved. But if, on the contrary, the political crisis aggravates, theshareholders would take corporate funds to avoid the sale of the assets by the financialinstitutions. At this level, these firms will undoubtedly face a financial distress.

Furthermore, Lebanese financial analysts, investors and accounting professionals,are constantly trying to find warning signs of financial distress. In this context, thisstudy intends to analyze the relationship between corporate governance and financialdistress. Lee and Yeh (2004) examined ownership structures (such as equities held)and board composition (such as board seats), forgetting about other governancecharacteristics (such as outside directors and female directors on the board) on whichfinancial performance might rely. Therefore, this paper seeks to associate full orrobust characteristics to the probability of financial distress. Consequently, thecorporate governance model structure aiming at improving corporate’s performanceand avoiding financial distress will be developed.

This paper will be presented as follows: on the first hand, we will present aliterature review and relevant hypotheses. On the other hand, we will establish theadopted methodology approach. Finally, we will discuss our results and conclusions.

Background and hypothesis development

Research context

The Middle East is a growing, lucrative marketplace that has recently captured theinterest of the world for political as well as economic reasons due to the War in Iraq,which began in 2003. Since the discovery of oil in the Gulf Region in the 1930s, theMiddle East has been in transition. The population of the Middle East has grownvery fast in the past 30 years faster than any other region of the world except sub-Saharan Africa. The subsequent increases in revenue have resulted in drastic changesand significant industrialization within these countries. Contact with Westerncountries and corporations improved the standard of living in the Middle Eastthrough better education, improved health care, greater mobility, and increasedcommunication (Ali 1993). Lebanon has been considered a vibrant market economysince ancient times, when the Lebanese, then called the Phoenicians, were the first tostart commercial transactions. The country is well known for its marketing prowessand its educated and talented population. Before the 1970s, Lebanon’s per capitaincome was similar to that of Southern Europe (Fahed-Sreih 2006), and the countrywas a commercial center for the entire Middle East.

Recent events, however, have undermined Lebanon’s historically healthyeconomy. A twenty-year civil war seriously damaged Lebanon’s infrastructure andcut its GNP output by almost half. After the war ended in 1991, Lebanon’s main

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growth sectors were tourism and banking. After the September 11, 2001 attacks,Lebanon was considered by the Arab world to be a safe place for deposits, as it practicesbanking secrecy and was no longer at war. Israeli occupation from 1978 to 2000 andSyrian occupation from 1978 to spring 2005 have left Lebanon with massive politicaland financial problems to solve, including physical and social infrastructuralreconstruction. The unanticipated 34-day Israel-Hezbollah war in July 2006 furtherdevastated the Lebanese economy. It is believed in Lebanon and the Arab world, morethan anywhere else in the world, that family businesses, rather than being a money-generating activity or a market-driven pursuit, are a way to enhance a family’s socialstanding (Fahed-Sreih 2006). Lebanese family businesses are the engine that drivessocioeconomic development and wealth creation, and entrepreneurship is a key driverof family businesses. This special way of managing a business in Arab countriesrelates to the socioeconomic and cultural backgrounds of these families (Ali 1993).

Lebanon’s corporate governance

Corporate governance in Lebanon is not yet well developed, but in the last fewdecades the government has taken some steps to make marginal improvements.Existing legal and regulatory requirements lack many important corporategovernance protection codes, especially with respect to the composition andoperation of boards of directors. The Lebanese economy is dominated by family-owned businesses that do not support transparent corporate culture and protocol,which in turn define the roles and responsibilities of those charged with conductingcorporate decisions. Lebanon’s experience with corporate boards and theireffectiveness as a control mechanism are not well known because of the lack oftransparency. Separation of ownership and control has not yet been fully realized.The commercial code, specifically Article 153, does not provide for the separation ofthe roles of the chairman of the board from those of the general manager: the board’schairman is responsible for executing the duties of the general manager unless he/sheappoints one on his/her behalf. The concept of truly independent outside directorsdoes not seem to have been utilized yet. The commercial code does not provide for aclear and enforceable definition of an independent outside director to guaranteeboard independence. The code only requires boards to have a minimum of threedirectors. The law does not provide adequate protection of shareholders’ rights orequitable treatment. A company is not legally obligated to share in company profitswith shareholders or to provide shareholders with complete disclosure of companyinformation. The law only obligates firms to disclose corporate charters along withinformation related to equity holders, their aggregate holdings, and shareholdermeetings to the Commercial Register.

Firms are also required by law to disclose budget-related information to theMinistry of Finance. However, it is not easy to access such information: first, the lawdoes not obligate governmental agencies to disclose company information toanyone; and second, the process of searching for needed company information istime consuming as it involves going through piles of related paper documents.Families control a majority of Lebanese companies, either through complex pyramidstructures or through ownership of a majority of outstanding voting shares. Pyramidstructures allow families to gain control of a number of holding companies and

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subsidiaries through ownership of a small equity percentage in each business. UnderLebanon’s Commercial Law, companies can issue shares with unequal voting rights,thereby allowing families to control companies by owning a minor economic interestin the business. Family owners have often-valued unrestricted control over theircompanies more than they have valued higher profits and finding the least expensiveform of finance. The main drawback of family-owned businesses is the lack ofindependence and objectivity needed to monitor the company’s activities, which forexample could lead to misappropriation of shareholder revenues by the controllingshareholder. Family control does not always result in bad governance. Although thecorrelation between corporate governance and firm performance is still not clearlyestablished, it is common business practice for firms to establish a board of directorsto monitor business performance, thereby protecting the company’s shareholders(Kosnik 1990). In addition, the dynamics and development of the corporateeconomy in developing countries is often different from those in countries withmore developed economies. Despite the limited empirical evidence of the role of theboard of directors in Lebanon, we attempt to shed light on how the corporatestructure faces financial distress.

This paper seeks to highlight the existing relationship between corporate governanceand financial distress (dependent variable). To that end, we will focus on six main factorsof corporate governance (independent variables): 1) outside/independent directors’presence on the board, 2) CEO-board chair duality, 3) insiders equity, 4) femaledirectors’ service on board, 5) the size of the board, 6) the time period of the directorserved on the board. If some of these characteristics are proved to be significant, firmsand governance experts will thus use it as a warning, predicting therefore a situation offinancial distress. If not, they will have to analyze the directors’ unethical behaviors andthe power dynamics of the board to explain the financial distress causes.

Literature review

According to Baldwin and Scott (1983, p. 505), “when a firm’s business deterioratesto the point where it cannot meet its financial obligations, the firm is said to haveentered the state of financial distress. The first signals of distress are usuallyviolations of debt covenants coupled with the omission or reduction of dividends”.Whitaker (1999) defines entry into financial distress as the first year in which cashflows are less than current maturities’ long-term debt. As long as cash flow exceedscurrent debt obligations, the firm has enough funds to pay its creditors. The keyfactor in identifying firms in financial distress is their inability to meet contractualdebt obligations. However, financial distress symptoms are not limited to firms thatdefault on their debt obligations. Substantial financial distress effects are incurredwell prior to default. Weisbach (1988) depicts a process of a financial distress thatbegins with an incubation period characterized by a set of bad economic conditionsand poor management who commit costly mistakes. Weisbach (1988) argues thatfirms enter financial distress as the result of economic distress, declines in theirperformance and poor management. In our literature review, poor performance willbe measured by a coverage ratio (defined as EBITDA/Interest Expenses).

The theoretical linkage between corporate governance and financial distressoriginates from organizational theory literature. In declining or crisis periods,


organizations often engage in a mechanistic shift, from which centralization ofauthority is the most widely recognized outcome (Daily and Dalton 1994). Theseauthors also argue that centralized authority has particular applications to therelationship between governance structure and bankruptcy. The issue of centraliza-tion of authority is applicable to the agency problem. It may be characteristic offirms in persistent financial distress to have weak corporate governance, as measuredby board composition and structure.

Hermalin and Weisbach (1988) supposed that the number of independentdirectors could increase on the board as a result of poor performance. Moreover,Baysinger and Butler (1985) considered that a high proportion of outside directorscould lead to a better performance According to the authors; this proportion keepsdeclining through the CEO’s career. In conclusion, poor performance seems to bedue to boards with few independent directors. On the other hand, Salloum andAzoury (2009) mentioned that various Lebanese firms establish formal boardcommittee that is assigned to monitor corporate disclosure. There has been littleprogress in improving Lebanese Board functions. Most boards have few non-executive directors and even fewer independent directors. Boards tend to play apassive role in reviewing management performance or in strategic planning.Nomination, compensation, or audit committees are rare. An insider-dominatedboard may be a potential explanation of distress in Lebanon. Outside directors morelikely guaranty transparency because of their position and independence. Accordingto Baysinger and Butler (1985), boards are not involved in the process of decisionmaking when there are a high proportion of insiders. In fact, they do not have theright to monitor the CEO. In that case, top management is dominating the board ofdirectors, which causes collusion, and transfer of stockholder wealth (Baysinger andButler 1985). Pfeffer (1972) also found that the boards of declining firms have ahigh percentage of insider directors. In the context of financial distress, the distressedfirms seem to have boards with low proportion of outsiders. Baysinger and Butler(1985) have also indicated that the board composition influences financialperformance. This means that financial distress could be due to an insider-dominated board. Based on this theoretical framework between financial distressand board of directors’ composition and structure, it is hypothesized that:

H1: A board with a smaller percentage of outside directors is positively linked tofinancial distress.

Through the analysis of accounting based measures of ROE, ROI and profitmargin, Rechner and Dalton (1991) noted that the firms that did not join the CEOand the chairman position exceeded the other firms. In fact, when the firm isbringing together these two positions, it is ruining two of its most important powerdynamics (Jensen 1993). The CEO, who is also the board chair, cannot be monitoreddue to his power, which allows him to take decisions for his own interests whileneglecting the shareholder’s. Elloumi and Gueyie (2001) asserted this evidence byanalyzing financially distressed firms. Moreover, Daily and Dalton (1994) found thatthese firms are more subject to bankruptcy in a particular way. The same applies toSalloum and Azoury (2009) who examined a sample of 71 non-listed Lebanesefirms. CEO duality is a common structure in Lebanon and relate to prestige andrecognition status in the Lebanese society. Most of these types of Lebanese firms


usually face kind negative operating income due to expenses related to non-firmsactivities and based on inappropriate extortion of firm’s funds. Thus, several resultsrelated to the relationship between CEO duality and corporate failures saw the light.Therefore, financial distress can be explained through the fact that CEO andchairperson of the board of directors are combined in one position. Based on thistheoretical framework between financial distress and CEO duality, the hypothesistakes thus the following form:

H2: A firm with the CEO duality is positively correlated with financial distress.

Jensen and Meckling’s (1976) considered for their part that firm performancedepends on the insider’s ownership (as top-managements’ shareholders), knowingthat it rises accordingly. In fact, insiders do not divert resources that are dedicated tothe optimization of shareholders value. According to Chen et al. (2003) for Japan,insider ownership is positively linked to firm performance. In UK, Davies et al.(2005) found that insider ownership is determined with firm value. For Switzerland,Beiner et al. (2006) also considered that insider ownership positively affects firmvalue. As for Germany, Kaserer and Moldenhauer (2008) noted that high insiderownership leads to a better performance and less chances of financial distress. InLebanon, Salloum and Azoury (2009) shed light on the existing connection betweeninside ownership and financial distress of non-listed firms. In Lebanon class sharestructures has an unequal voting right. The protection of minority shareholder rightsis the key to improving corporate governance in Lebanon. Gilson (1990) consideredfor his part that the modifications that might target the board composition and theinside equity ownership could probably lead to financial distress. In conclusion, itseems that insider ownership is well influential. Consequently, financial distresscould definitely be justified by the small insider’s ownership. According to thistheoretical framework between financial distress and insiders’ ownerships, thehypothesis is thus as follows:

H3: The smaller the equity ownership held by insiders, the greater the probabilityof financial distress.

The study conducted by Burke (1994) in Canada revealed that about half of theCEOs/board chairmen would rather choose female directors. In fact, they considerthat female directors urge the boards to get adapted to drastic changes that affect firmperformance, such as unstable impulsive markets, increasing international compet-itive pressures and new and complex technologies. Van der Zahn also noted a linkbetween female directors in South Africa and firm performance. Besides, femaledirectors positively affect firm value over time. In Japan and Australia, a study wasrecently conducted, revealing a relationship between female directors, firmperformance and financial distress (Bonn et al. 2004). In Spain, Campbell andMinguez-Vera (2007) suggested that the stock market is also affected by theappointment of female directors because investors and potential partners believe thatfemale directors contribute to the improvement of firm value. In a sample of 71Lebanese firms, Salloum and Azoury (2010) found that financial distress is not theresult of the female directors on the boards, which does not explain financial distress.Lebanese directors are motivated by the need for achievement, flexibility in theirlives, and the desire for family security. Around 10% of Family owned Business in


Lebanon is managed by women due to succession of heritage. Resources in Lebanonare managed differently by gender; the masculine approach to resources is to findways to obtain and use them by leveraging rather than sacrificing the owner’sresources. The feminine approach is more personal; the individual is fully at risk andmakes a deeper personal commitment to both the opportunity and the resources,including employees. Females tend to encounter greater barriers than males inobtaining business credit. They tend to be more risk averse than males, thus takingon smaller loans. They perceive and approach business differently than men. Thus,according to this theoretical framework between financial distress and female directornomination, the hypothesis is thus as follows:

H4: A firm with female director is negatively linked to financial distress.

According to Jensen (1993), larger boards are efficiently incapable of monitoringtop management. They also cause financial distress. After observing firms in Finlandand Eisenberg et al. (1998) concluded that low performance is negatively associatedto large boards. Based on firms in Singapore and Malaysia, Mak and Kusnadi (2005)suggested that board size and firm performance are also well linked. Lipton andLorsch (1992) considered that large boards are not as effective as smaller boards. Infact, a larger board impedes the coordination, which prevents boards fromparticipating in strategic decision-making. Yermack (1996) supports this argumentthrough empirical evidence. Salloum and Azoury (2010) considered for their partthat financial distress status highly depends on board size; larger boards could leadto financial distress. Lebanese’s board sizes are usually tended to be larger thannormal. Being a member of the board is usually associated to prestige andrecognition only without any effectiveness or added value because it’s the CEO orthe founder that takes all decisions within the firm. They usually are political andmilitia members. In fact, the firm is unable to benefit from the expertise and servicesof the directors’ on the board if it is too large.

In this framework, there are actually many findings related to the link betweenboard size and corporate failures. In conclusion, large board size could justify thefinancial distress status. Based on this theoretical framework between financialdistress and large board size, the hypothesis is thus as follows:

H5: A firm with larger board size is positively correlated with financial distress.

Short tenure directors and longer tenure directors do not have the same firmknowledge. Thus, they are unable to act in favor of the equity owners’ interest.According to Stewardship, executives should be stewards taking care of theshareholders’ interests (Donaldson and Davis 1989). They should also preserveand maximize their wealth with the help of firm performance. Consequently, thesteward’s functions are well improved (Davis et al. 1997). Furthermore, shortertenure directors are not well experimented, which explains the financial distress oftheir firm. In this context, Salloum and Azoury (2009) analyzed a sample of 71Lebanese owned family firms and concluded that boards of 12 years could also leadto financial distress, considering that the board members lacked monitoring andintellectual capital use. Thus, the authors qualified Lebanese directors as passive.The tenure of a director on board could represent one way to measure hisstewardship. In this paper, the number of directors that have served on the board for


longer than 9 years is used to measure the variable because 9 years is the averageperiod in which a director is appointed in the Lebanese’s public sector.

H6: The shorter a director has served on a board, the greater the probability that thefirm on which he or she serves has financial distress status.

Research method

The Lebanese Republic provides a unique living laboratory in which to explorefamily business development. Although there is an emerging body of knowledgeabout entrepreneurship and private-enterprise development, there are few in-depthempirical investigations. Firms in Lebanon have gone through harsh years of warand survived, despite the heavy shelling and uncertainties facing their businesses andthe country at large. Given the turbulence in the country in recent decades, it comesas no surprise that Lebanon has low scores when it comes to economic performance.

Consequently, researchers have a unique opportunity to identify, probe, and analyze thecharacteristics of family business’s corporate governance while facing financial distress.

The sample used in this study consists of 178 family business firms (SME’s withan average of 133 employees), 89 of which are in financial distress because theyhave experienced negative operating income between 2004 and 2008. Each of thefinancially distressed firms is matched with a healthy firm, creating a choice-basedsample of 89 distressed and 89 healthy Lebanese firms.

The database of this research includes owned family business with lack of loanprincipal/interest payments and bankruptcy. In order to extend the research, the studyused the annual reports related to these companies and addressed a questionnaireabout the financial distress causes. We were able it identify 200 firms that fell into afinancial distress. We then eliminated the firms that were taken over, and got 89financially distressed firms. We paired each financial distress firm with a non-financial distress firm by using codes and firm size.

Afterwards, we make sure that non-financial distress firms did not experience anyfinancial distress during the elaboration of this study. We limit our research to firmsthat only experienced financial distress between 2004 and 2008. All corporategovernance variables for financial distress and non-financial distress firms aremeasured starting from the year (2003) prior to the studied period (2004–2008). Aquestionnaire survey was addressed to important persons in top management whoknew which information were needed. The respondents were family members andCEOs (founders and successors). It allowed us to collect all the corporategovernance variables. For firm size, we used market debt value, number ofemployees, and asset size to both groups. For industry effects, we also matched eachfinancial distress firm with a non-financial distress firm, with the same first twodigits of the code so that we could do a paired firm analysis (Table 1).

The majority of companies in Lebanon are small and medium enterprises (SMEs)employing less than 150 employees. The few large companies that do exist tend tohave dominant market positions making it difficult for new entrants to establishthemselves. Almost 60% of the firms were corporations or LLCs. Only 50% of theentrepreneurs indicated they had originated their enterprises, while approximately


one-third inherited their business. Family participation was found to be critical. Theyprovide primary sources of start-up capital. Over 50% of the businesses had morethan one family investor; 70% had a family member employed full time.

This importance of family extends to businesses, where approximately 95% of allprivate sector companies in Lebanon. It has a long tradition of family dominanceover both rulers and business. Historically, companies have relied heavily onretained earnings to fund growth and expansion, with bank financing being the mainsource of external funding for businesses.

Lebanon’s equity market is relatively underdeveloped compared to other countriesin the region. Total market capitalization of the 16 companies listed on the BeirutStock Exchange (BSE) stood at $3.3 billion at the end of June 2010, about 15% ofestimated GDP which is small relative to the regional average of 40% of GDP. Aprolonged period of civil unrest and a culture of family ownership of businesses aretwo of the main reasons for the nascent equity market.

The unfavorable business culture in Lebanon constitutes an obstacle to thedevelopment of a capital market in the country. The culture that is predominant inthe local market is the family-type business culture, which is not favorable for thedevelopment of a financial market. Challenges facing the development of a financialmarket in Lebanon are the lack of central the obsolete technology platform.

Afterwards, we make sure that non-financial distress firms did not experience anyfinancial distress during the elaboration of this study. We limit our research to firms

Table 1 Sample selection

Sector Initialnumber

Financialdistressed firms

Non-financialdistressed firms

Agriculture 7 4 4

Chemical products 6 3 3

Construction materials manufacture 9 4 4

Cosmetics 5 2 2

Distribution 24 9 9

Electrical equipment & supplies 6 3 3

Financial services 25 13 13

Food industry 13 6 6

Hospitality industry 23 14 14

Jewelry 8 3 3

Media & telecommunications 8 4 4

Pharmaceutical industry 4 3 3

Private contracting industry 10 3 3

Publicity & advertisement 6 3 3

Publishing & printing industry 8 3 3

Services 20 8 8

Textile industry 6 2 2

Tourism & leisure 12 2 2

Total 200 89 89


that only experienced financial distress between 2004 and 2008 (the studied period).All corporate governance variables for financial distress and non-financial distressfirms are measured starting from the year (2003) prior to the studied period (2004–2008). A questionnaire was addressed to important persons in top management whoknew which information were needed. It allowed us to collect all the corporategovernance variables. For firm size, we used market debt value, number ofemployees, and asset size to both groups. For industry effects, we also matched eachfinancial distress firm with a non-financial distress firm, with the same first twodigits of the code so that we could do a paired firm analysis.

We conducted a logistic regression analysis in order to evaluate the probability offinancial distress. Financial distress score is recoded as 1 for the firm with financialdistress; 0 with non-financial distress. This score was modeled as follows:

F financial distress ¼ 1ð Þ ¼ 1= 1þ e� yð ÞAnd y ¼ a0þ b1»VAR1þ b2»VAR2þ b3»VAR3þ . . .þ b8»VAR8

Where VAR1-VAR7 is corporate governance characteristics (gender, length ofdirector tenure) and VAR8 is the firm size. For the impact of firm’s size, we includedthe firm’s number of employees as a proxy for the firm size. The variables anddescriptions are defined as follows:

NOUT Number of total outside directors;CEOD Number of CEO duality;INSO Insiders have 0 equity ownership;DWO Directors are women;DTO Total number of directors;DI9 Directors over 9 years of tenure;EPL Number of employees;DEB Market debt value in USD;POUTD Percentage of directors that are outsiders.

Dependent Variable is whether the firm will face financial distress or not.Financial distress firms are coded as 1 and 0 otherwise. Independent variablesinclude corporate governance characteristics.

We defined financial distress with the measure used by Asquith et al. (1994)based on coverage ratio. A firm is considered to be in financial distress if itscoverage ratio (defined as EBITDA/Interest Expenses) is less than one for twoconsecutive years or if it is below 0.8 in any given year. Firms in financial distressare identified with the dummy variable defined below.

A dummy variable of 1 and 0 was used to differentiate between financiallydistress companies and healthy companies. We used a binary variable that equals one(1) for distressed companies and zero (0) for non-distressed companies were used.We used a dummy variable to enable us to use a single regression equation torepresent multiple groups. Independent variables include corporate governancecharacteristics. The market debt value was used instead of the market capitalizationfor additional information only as the firm’s value.

Table 2 presents the descriptive statistics in the study. Total sample of 178 firmsinclude 89 financial distress firms and 89 non-financial distress firms. It presents


descriptive statistics for each variable. For example, the average number of femaledirectors for the sample is .04 and the maximum number of female directors for oursample is 2. Table 3 presents the correlation coefficient matrix. Results derived fromthe Table indicate that multicollinearity among the independent variables is not aproblem.

Tables 3 and 4 present the results of mean value and mean difference of corporategovernance between two groups: Financial distress firms and non-financial distressfirms.

According to Table 4, three mean differences are significant. These are directorsover 9 years of tenure (DIR9), total number of directors (DTO), and percentage ofdirectors that are outsiders (POUTD).

Independent samples T test indicate that financial distress firms, on average, haveless directors over 9 years of tenure, larger board size, and lower percentage ofoutside directors than matched non-financial distress firms.

Analysis and results

The results of the logistic regression analysis and the interpretation of the hypothesesare presented in this section.

Table 2 Descriptive statistics and correlations for the main variables

Variable Sample size Minimum Maximum Mean Std. dev.

NOUT 178 0 9 1.45 3.014

CEOD 178 0 2 1.28 1.339

INSO 178 0 3 .76 1.234

DWO 178 0 2 .04 .282

DTO 178 4 18 8.19 2.886

DI9 178 0 5 1.39 3.506

EPL 178 45 199 113.2 32.418

DEB 178 211,375,449 9,311,555,912 4,124,009 5,208,113

Table 3 Correlation matrix among corporate governance variables

NOUT CEOD INSO DWO DTO DI9 EPL

NOUT 1

CEOD −.711 1

INSO .906 .401 1

DWO 1.323 .067 −.061 1

DTO 2.510** 1.628** .024 −.038 1

DI9 1.312 0.21 −.12 .037 .0997 1

EPL .414 .062 .081 .022 .083 .019 1

The number in the table is t-value. **, *: Significant at .05 and .1 levels respectively


In Table 5, two variables are significant in the models: percentage of outside directors(POUTD) and total number of directors (DTO). Results indicate that firms with a lowerpercentage of outside directors are more likely to fall into financial distress status andthat firms with a large board size are more likely to fall into financial distress status.

F financial distress ¼ 1ð Þ ¼ 1= 1þ e� yð Þand y ¼ a0þ b1»VAR1þ b2»VAR2þ b3»VAR3þ . . .þ b8»VAR8

Table 4 Mean value of corporate governance variables: Financial Distress Firms (1) and Non-FinancialDistress Firms (0)

Corporate governance FNF vs. NFDF Sample size Mean Std. dev. Std. error

DI9 1 89 0.28 2.298 0.953

0 89 2.49 1.138 0.717

CEOD 1 89 1.91 1.027 0.072

0 89 0.65 0.409 0.222

DWO 1 89 0.03 1.225 0.713

0 89 0.06 1.123 0.418

DTO 1 89 9.24 2.054 0.339

0 89 7.13 1.114 0.226

NOUT 1 89 0.77 2.295 0.474

0 89 2.13 1.579 0.304

INSO 1 89 1.24 1.968 0.295

0 89 0.28 1.572 0.274

EPL 1 89 918 30223.16867 576.754 4092

0 89 1,486 20067.60443 261.917 4954

POUTD 1 89 0.02 0.178 0.106

0 89 0.14 0.827 0.211

This table summarizes the mean values of each variable for both groups

Table 5 Independent samples T test for equality of means

Corporate governance Mean difference F-statistics Sig. T-statistics

CEOD 1.21 .039 .72 .352

DWO −.02 .391 .187 −.501DI9 −2.07 1.784 .038** −2.038DTO 2.22 1.712 .012** 2.328

INSO .77 .226 .307 1.038

EPL −4 11 2.135 .257 −1.361POUTD −.15 11.124 .002*** −3.069

This table compares mean values of corporate governance between two groups: Financial distress firmsand non-financial distress firms. Mean Difference is calculated as Financial distress firms (1)—non-financial distress firms (0). F-statistics, Significance level, and T-statistics are provided. **, ***:Significant at .05 and .01 levels respectively


Where VAR1-VAR7 is corporate governance characteristics (gender, length ofdirector tenure) and VAR8 is the firm size. For the impact of firm’s size, we includedthe firm’s number of employees as a proxy for the firm size (Table 6).

A positive regression coefficient means that the explanatory variable increases theprobability of financial distress while the negative means that the variable decreasethe probability of financial distress. It’s a way of describing the relationship betweenone or more independent variable and a binary response variable (financial distress).As for Models’s equations (multiple regression), we have included and removedadditional variables in the 5 models in order to estimate and confirm their effects onthe dependent variable as well.

H1: A board with a smaller percentage of outside directors is positively correlatedwith financial distress.

The hypothesis is confirmed. Since the number of outside directors varieswidely, we standardize this variable by dividing the number of outside directorson a given board by the total number of directors on the board. Since outsidedirectors presumed independence are less subject to CEO control than insidedirectors, they may be more inclined to press auditors to investigate thoroughlyand to test financial results carefully, leading to a reduction in the probabilityof financial distress.

H2: A firm with the CEO duality is positively correlated with financial distress.

The hypothesis is not supported. The correlation is insignificant and positiveas predicted. The correlation is insignificant and positive as predicted. Theduality gives CEO more opportunities to make decisions according to self-interest or entrenchment-seeking purpose, or he or she may undertake perquisiteconsumption. The duality would help explain why the correlation is positive.Daily and Dalton (1994) observed that firms with the CEO serving as boardchairman are more likely to go bankrupt. Our result is insignificant. The possibleexplanation is that our data fails to capture the negative effects of the CEO dualityon firm performance.

Table 6 Regression results of the models based on different variables

Model 1 Model 2 Model 3 Model 3 Model 4 Model 5

INSO −.421 −.319DI9 −.139 −.182 −.254 −.151CEOD .610 .042 .054 .112 .158

DWO .207 .173 .042 .238

DTO 2.119** 2.408** 2.329** 2.164**

POUTD −2.151** −2.484** −2.199** −2.234**EPL .0002 .0002 .0002 .0002

Log Likelihood 356.40 398.21 277.51 185.73 248.18 238.92

Model x2 29.87** 26.73** 19.71** 18.55** 11.24** 19.06**

**: Significant at .05 levels


H3: The smaller the equity ownership held by insiders, the greater theprobability of financial distress.

This hypothesis is not supported. The correlation is negative as predicted and isinsignificant. Since we used a binary approach-share ownership vs. no shareownership-the regression model did not discriminate between large and smallinsiders. An insider may own ten shares, but this level and value of ownership maybe too small to introduce any bias. Nevertheless, equity ownership by insider is oftenthought to have information content because they had inside information. When theirfirms are not performing well, insiders will reduce their equity holdings. On theother hand, if their firms as a whole create good performance, they are more willingto hold more equity because the operating income may increase. Or, as we suggestwith respect to this hypothesis, whether the firm is associated with financial distressmay look into equity ownership held by insiders.

H4: A firm with female director is negatively correlated with financial distress.

This hypothesis is not supported. The failure to find a correlation could be due toseveral factors. First, the number of women on board is very limited. The mean isonly .04. It might be more revealing to look for a correlation between the percentageof female board members and financial distress. Therefore, we also divide thenumber of female directors by total directors on the board and re-run the regression.The results are similar: no significant correlation. Having women on the board doesnot seem to reduce the probability of financial distress.

H5: A firm with larger board size is positively correlated with financial distress.

This hypothesis is confirmed. Board size and financial distress are positivelycorrelated. Large board is always believed to be an ineffective monitor. As wenoted in our discussion of this hypothesis, larger board is associated with lowerfirm value. This reason results from the inherent problem of inability of largeboard to control manages. While larger board may have wider discussions onpolicies of top management, these discussions do not ensure effectivemonitoring. In the short run, perhaps ineffective monitoring may not causeimmediate financial distress. However, in the long run, the accumulatedineffective monitoring may be the trigger of financial distress. Moreover, ithas never occurred that a firm with ineffective monitoring can eliminateunethical behaviors of management. Largeness is not an infallible indicator thatdirectors coordinate to confront CEO.

H6: The shorter a director has served on a board, the greater the probabilitythat the firm on which he or she serves has financial distress status.

He or She serves has financial distress. This hypothesis is not supported. Thecorrelation was insignificant and negative. It is equally probable (or improbable) thatshort-serving directors will be associated with financial distress firms. A monitoringmanagerial behavior may require well knowledge of the firm. In some case, shorter-tenured directors may not have sufficient firm-specific knowledge needed to controlmanagers. Another possibility is that shorter-tenured directors may not be any moreprobing than longer-serving directors.


Limitation

The results of this study are subject to two major limitations, some of which affectmany exploratory studies. First, our data were gathered in only one country in theMiddle East. Although this adds to the richness of the study, it also limits our abilityto predict from it. Second, the surveys were completed by a convenience sample offamily businesses that may not represent the larger population. Convenience samplesare always suspected in generalizing to a population, but this sample is fairly largeand comprehensive.

Conclusion

Few studies have tackled the relationship between corporate governancecharacteristics and Lebanon’s corporate financial distress. Consequently, thispaper represents a small step towards the exploration of this specific relation. Itanalyses, in fact, the contribution of some governance characteristics to thefinancial distress that the Lebanese economy has experienced. We were ablebesides to reach some results that are similar to prior papers related to thecorrelation between governance characteristics and financial distress predictions.Our main conclusion revolves around the fact that a high proportion of outsidedirectors on the board are negatively associated to financial distress. Somestudies that were also mentioned in our literature review are somehow in linewith another result. It suggests that board independence improves firmperformance. Furthermore, poor financial performance is not resolved whenthe firms increase the number of outside directors on board. In addition, boardsize is also associated to financial distress while other characteristics turned outto be insignificant. In spite of the importance of qualitative institutional andcultural factors, governance has only been analyzed through a quantitative pointof view. In conclusion, we would highly appreciate new papers that analyze theinfluence of managerial power on board dynamics. It is noteworthy that theseresults are promising; nevertheless, they should be cautiously approachedwithout transcending the context provided in this study.

As the Middle East enters a new phase of growth and integrates moreclosely with the global economy, family businesses that ignore corporategovernance now are likely to lose their competitive edge in the future. Tribalsocieties have long focused on the family as the unit of interest. Familiespredominate in both politics and society. This importance of family extends tobusinesses, where approximately 95% of all private sector companies inLebanon. It has a long tradition of family dominance over both rulers andbusiness. This tradition has been traced to feudal times, but is pervasive eventoday.

The Lebanese government’s efforts to implement financial reforms have beenimpeded by political uncertainties and lack of consensus. There has been littleprogress in reestablishing the equity culture lost during the civil war, or in reforminga number of weaknesses in the legal and institutional corporate governance structure,leaving Lebanon in the bottom tier of emerging markets.


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