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Examination of NZ Finance Company Failures: The Role of Corporate Governance
Abstract
Recently any difficulty a financial institution found itself in seems to have been blamed on the global financial crisis. This paper, employing forensic case study analysis of finance companies in New Zealand rebuts this excuse. Instead, it is argued the large number of failures in New Zealand finance companies in the last four years was due to a failure of regulation and corporate governance, occurring well ahead of the global financial crisis.
... 2. Regulatory environment for financial institutes A review of New Zealand's legislative environment is important when attempting to understand the causes and effects of the collapse of financial companies. In this country, the legal environment for depositors and financial companies is considered weaker than in the developed world (Wilson et al., 2010). Wilson et al. (2010) describe New Zealand's legal system regarding Non-Bank Deposit Takers (NBDT) as retarded and unclear. ...
... In this country, the legal environment for depositors and financial companies is considered weaker than in the developed world (Wilson et al., 2010). Wilson et al. (2010) describe New Zealand's legal system regarding Non-Bank Deposit Takers (NBDT) as retarded and unclear. Starting in the last quarter of 2007, efforts were made to tighten up financial sectors, including financial companies and financial brokers. ...
... Kohlbeck and Mayhew (2017) also argue RPTs signal that management is willing to self-deal, causing more self-centric action. The research results of Wilson et al. (2010) show that shortcomings in regulations and corporate governance are the main sources of financial company failure in the years before the global financial crises. ...
Abstract
Purpose - This research examines the existence of related party transactions (RPTs) in failed financial companies in New Zealand when firms have interlocking directors on the board. We also examine the role of auditors in our review of RPTs. We anticipate that inter-company director relationships promote RPTs while reputable large auditors (i.e. Big4) restrict the practice.
Design/methodology/approach – This study uses multivariate analysis to examine the determinants of related party transactions. We use a unique, hand-collected database of New Zealand finance companies all of which collapsed during the years 2006-2011.
Findings – Using a sample of 65 firms (including 38 failed finance firms) and 219 firm-year observations, we found that almost half of the failed finance firms were engaged in related party transactions. For the failed firms, those that were engaged in RPTs were mostly represented by interlocking directors and were audited by non-Big4 auditors, implying lower monitoring quality may facilitate RPTs. Using a sub-sample, we also found evidence that firms engaged in RPTs were later convicted of questionable accounting and disclosure practices.
Research implications – This research is beneficial to regulators and audit professionals in understanding the potential for adverse outcomes associated with interlocking directors and undisclosed related party transactions. While interlocking directors could enrich the external connections of a firm which might facilitate capital resourcing, our study suggests regulators might encourage firms to disclose related party transactions when the firm has higher interlocked directors.
Originality/value - Our study is the first to examine the association between RPTs and interlocking directors using a sample of failed finance companies. Related party transactions and lack of disclosure were widely attributed with being the determinants of corporate failure in the finance sector. However, failed finance firms remain widely under-researched because of a lack of available data. We circumvent this limitation by using print media and business news portals to collate information on related party transactions and interlocking directors. While prior research indicates that weak corporate governance leads to poor accounting practice, using the interlocking board as a proxy for weak corporate governance, we are the first to substantiate the adverse effect of interlocking boards and undisclosed RPTs with corporate failure.
... Similar results were shown by Abdul-Wahab et al. (2011) in Malaysia. Moreover, a study conducted by Wilson et al. (2010), using a sample of financial companies in New Zealand, indicated that there are common characteristics among failing companies. ...
... In January 2009, a large financial planning firm, Storm Financial, entered administration and ultimately failed, with many clients suffering major losses from highly leveraged investment portfolios. mission extended only to checking compliance with the trust deed and even there powers of enforcement were very limited (Wilson, Rose and Pinfold, 2010). ...
This paper argues that there were two key factors behind the resilience of Latin American financial systems during the crisis. The first was the initial conditions that a number of countries in the region faced during the pre-crisis years. Sound macroeconomic policies and highly improved financial regulations were in place at the time the crisis erupted. This meant that banks and other financial institutions stood on a good footing when the external shock hit. The second factor (highly related to the first one) was the appropriate response of policymakers in several countries in the region to deal with the impact of the shock. In particular, and departing from previous crisis episodes, a set of Latin American countries were in a strong position to implement counter-cyclical monetary (and some even fiscal) policies that minimized the contraction of credit growth to the private sector and contributed to a rapid economic recovery. A third factor, not discussed in this paper, but well documented elsewhere (see Izquierdo and Talvi, 2008) is that the region also benefited from some doses of good luck. The external environment remained friendly to Latin America on two counts. First, following the initial impact effect from the collapse of Lehman, the response from the US Federal Reserve Board was to lower the Fed funds rate sharply and keep it low, which eased the external financing conditions to the region. Second, supported by the high growth of Asia (especially China), the prices of commodities exported by the region recovered in 2009 and, though they have been quite volatile, have remained
quite high since then. Thus, in the assessment of Latin America’s performance during and after the crisis it is only fair to conclude that the role of improved macro/financial regulatory conditions was facilitated by a combination of low interest rates in industrial countries and favorable terms of trade.
Purpose
This study aims to explore the role of corporate governance (CG) characteristics on the financial performance of large agricultural companies in New Zealand. External auditor remuneration and board characteristics, such as board ownership, board compensation, board independence and board gender diversity, are addressed in the context of New Zealand’s agricultural companies by applying agency theory.
Design/methodology/approach
This paper uses a balanced panel data generalised least square regression analysis on 80 firm-years of observations over the period from 2012 to 2015.
Findings
Empirical analysis revealed that external auditors’ remuneration and board characteristics, such as board compensation and board independence, except for board ownership and board gender diversity, held no association with the agricultural companies’ performance. While board ownership and board gender diversity were negatively, but significantly, associated with firm performance, these results were pronounced in the listed agricultural companies rather than in the non-listed companies.
Research limitations/implications
This study encountered limitations commonly associated with the majority of industry-specific studies, i.e. small sample size and lack of published financial information from databases. Therefore, for generalisation, these limitations were considered relevant.
Practical implications
The results of this research project are beneficial for authorities and agricultural company directors in implementing CG principles and guidelines to empower such companies in international competition. Encouraging agricultural companies to maintain a high level of transparency in financial reporting is of central interest for the government’s economic development, and stock market investors achieve a high level of transparency in non-financial disclosures, the chief objective of this study. Finally, the results of this paper may encourage auditors to scrutinise CG disclosures by agricultural companies in more detail, looking for undisclosed information.
Social implications
The results of this paper may encourage managerial transparency by providing appropriate disclosures for the public benefit. Investors may benefit from the disclosure provided in their economic decision-making and the public may expand on the information disclosed in facilitating development through exports, expansion of foreign investments and the indigenous economy.
Originality/value
The findings contribute to the literature by providing novel and original insights into using a sample of listed and non-listed agricultural companies to extend the current understanding of the governance-performance nexus.
Livestock, agriculture, and horticulture products are essential in the New Zealand economic sustainable development. Consequently performance and governance of active companies in these areas of business are constantly monitored by the public through legislators, stock market, government agencies, and media. Practically corporate governance disclosures are providing essential information for such monitoring and analysis. This paper intention includes critically evaluate corporate governance disclosures of agriculture companies. Implementation of the content analysis methodology enables this research project to present analysis of the level of compliance with the 2004 Corporate Governance Principles and Guidelines that put forwarded by the New Zealand Stock Exchange (governance related disclosure and their non-listed counterpart as expected providing even less disclosure in this area. The financial and governance reports of these companies are suffering from deficient transparency in the area of corporate governance.
During the period 2006 - 2010, 49 finance companies, in New Zealand, collapsed or entered moratoriums, owing investors in excess of $8 billion, and the fingers of blame continue to point in circles. The blame for this tremendous financial crisis is extensive and a consolidation of arguments is essential for the wider understanding of the topic and to put responsibilities into perspective. A part of this paper is to recognize who can and is being held legally responsible for investors’ sake, and also identify parties who have failed their responsibilities. We have highlighted the major issues created by corporate governance being the most direct cause of finance company failure in NZ. We believe in some way these findings will help avoid a similar crisis in the future and resolve a still commonly blurred line in public opinion.
This article uses the recent implosion of the finance company sector in New Zealand to examine a number of questions. In the period between the upsurge in the default rate in 2006 and the implementation of a Government Guarantee Scheme in October 2008, we find that the debt risk premiums within the deposit rates of these institutions were grossly inadequate to compensate for default risk, that depositors continued to make significant new deposits even into firms that failed shortly afterwards and that the failure of the companies to increase the risk premiums was likely out of concern that this would aggravate perceptions of default risk.
Purpose – During the period 2006-2010, 49 finance companies collapsed or entered moratoriums, owing investors in excess of $8 billion, and the fingers of blame continue to point in circles. The blame for this tremendous financial crisis is extensive and a consolidation of arguments is essential for the wider understanding of the topic and to put responsibilities into perspective. A part of this paper is to recognise who can and is being held legally responsible for investors’ sake, and also identify parties who have failed their responsibilities. We believe in some way these findings will help avoid a similar crisis in the future and resolve a still commonly blurred line in public opinion. Methodology/Approach – This paper is based on a review of prior studies, publicly available information, media and government reports on the topics contributory to the financial companies collapse. We question the degrees of responsibility of a number of variables including but not limited to: Financial Advisors, The Securities Commission, the effectiveness of bond covenants (and trustee companies), Auditors, GAAP and of course corporate governance. Findings – Discussed the main contributors to the collapse from authorities in the field and with applicable examples. We have highlight the major issues created by corporate governance being the most direct cause of company failure, while defining to what degree more secondary responsibility to failures contributed to the actual company collapse as opposed to simply failing their responsibilities to individuals or the public. Implications – Create a better understanding for readers through consolidated ideas of causes of the finance company collapses in New Zealand. Value – This paper highlight the differences between: how specific factors directly caused companies to collapse, and where these factors failed to protect individuals and the public from the financial crisis. Therefore our results have interest for accounting standard setters, auditors, policy makers and regulatory bodies. Further, it is argued that these factors are not unique to New Zealand but have relevance globally.
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