Impact of Corporate Governance on Organizational Profitability of TESO Plc

This research project aims to analyze the impact of Corporate Governance (CG) on the profitability of TESO Plc. It investigates the relationship between board size, CEO duality, and independent directors with profitability. The study provides a comprehensive literature review on agency theory, board size, CEO duality, and board independence. The research is conducted in the context of TESO Plc, a UK-based grocery store, and aims to contribute to the understanding of the influence of CG on organizational profitability.

Impact of Corporate Governance on Organizational
Profitability of TESO Plc
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Table of Content
Introduction of the Project …………………………………………4
Sections of the Report………………………………………………...5
Context ……………………………………………………………………….5
Research Question……………………………………………………….6
Aim and Objectives of the study ………………………………….6
Literature Review………………………………………………………….6
Agency Theory………………………………………………………………7
Board Size …………………………………………………………………….8
CEO Duality……………………………………………………………………8
Independent Director……………………………………………………9
References……………………………………………………………………11
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1) Introduction and Context to the project
Several previous pieces of research have been conducted to investigate the importance of
Corporate Governance (CG)but most of them are from a shareholder perspective
(Rahman, et al.,2019). Fewer research has been done that evaluates the influence of
corporate governance (CG) on the profitability of a firm (Meah et al.,2019). It is assumed
that corporate governance (CG) is one of the crucial attributes that can help to determine
the firm’s profitability. It is also believed that there is a link between Corporate
Governance (CG) and firms’ profitability (Rahman, et al.,2019).
A very comprehensive investigation is conducted on the relationship of corporate
governance (CG) with profitability. Corporation and their association with profitability
are considered an important area of theoretical as well as empirical study in business and
corporate research (Schauble,2019). Over the last few decades, the importance of
corporate governance on organizational performance has increased day by day. Therefore,
corporate governance has gained more attention as an essential part, not only from a
shareholder perspective but also from the organizational overall performance (Wahyudin
and Solikhah, 2017). Well-managed mechanisms of corporate governance (CG) play a
crucial role in improving organizational performance (Zulvia and Serly, 2020). Good CG
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can influence in many ways, for instance, a firm’s image can be improved, the confidence
of shareholders can be increased, and most importantly, the risk of fraud in the firm can
be reduced. There are various consistent mechanisms such as external environment and
internal control systems that significantly contribute to a firm’s success also affected by
corporate governance (Yammeesri and Herath, 2010).
The main rationale of CG is to maximize the firm’s performance by formulating and
implementing the appropriate strategies that encourage the corporate shareholders to
maximize the operational as well as market efficiency of a company (Wahyudin and
Solikhah, 2017). Moreover, good corporate governance constrained the power of insiders
which helps to control the misuse of organizational resources (Yammeesri and Herath,
2010).
It is contended that the corporate governance (CG) is highly concerned about the firm’s
profitability and continuously encourages the management to focus on the profitability
level of the firm that leading to an increase in the value of the firm and maximizing the
financial gains for shareholders (Ahmadpour,2012).
No doubt, a lot of research has been conducted on CG but less work has been done that
evaluates the impact of corporate governance on a firm’s profitability. Due to that reason,
currently, this research area has captured the limelight (Anderson et al., 2004).
Therefore, this project is conducted to investigate the influence of Corporate Governance
on profitability of company. Three determinants of corporate governance (CG) such as
Chief Executive Officer duality simply known as CEO duality, outside directors NEDs
and, the board size of the company are used in this study . These variables are used to
determine the corporate governance also used by (Bodaghi et al., 2010; Baptista et al.,
2011; Guillet et al., 2013) and earnings before interest to a total asset (EBIT/Total Assets)
is used to determine the profitability of the firm. The influence of corporate governance
(CG) on a firm’s profitability is evaluated with the help of determinants of Corporate
Governance and profitability ratio.
1.1) Sections of the Report
This study comprises on 5 sections. Introduction and context of the study fond in section
1. Aim and Objectives are found in section 2 and 3 section based on literature review.
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Concluding remarks and brief introduction of methodology are in 4 section and 5 sections
based on references.
1.2) Context
The focus of this piece of work is on UK based grocery store known as TESCO plc. It can
be said that this research work is conducted to investigate the impact of the corporate
governance of TESCO on its profitability. This project can be helpful for the company to
understand their strength and weaknesses regarding corporate Governance and improved
its standard of corporate governance that ultimately leads to improve the performance of
company.
TESCO is one of the renowned and largest British multinational general merchandise
retailer and grocery stores and public Limited Company. It is operated in several
countries and is considered the market leader in the United Kingdom and has a 28.4
percent market share (TESCO plc,2021).
It is the third-largest retailer based on its gross revenue all over the world. According to
the current annual report (2021) of TESCO, its operating income is £1.815 Billion, its
revenue is £ 6.147 Billion, its total Asset is £10.087 Billion and total equity is £12.325
billion. TESCO has provided employment to more than 367000 people all over the world
(TESCO plc,2021).
It is considered that the Corporate Governance at TESCO is very effective due to its
transparent structure Emma, (2022). Now, the question arises:
1.3) Research Question
Is there any impact or influence of CG on the profitability of TESCO? This study is
conducted to answer this question.
This research work can extend the literature on a firm’s profitability by using the
attributes of CG that can be helpful to minimize agency conflict between management
and other shareholders of the firm. However, this research work is an attempt to
investigate profitability from the perspective of Corporate Governance. This work is
assumed as a commendable addition as it determines whether corporate governance has
any influence on the profitability of an organization.
2) Aim and Objectives of this Research Work
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2.1) Aim
The main aim of this work is to analyze the impact of CG on the firm’s profitability.
2.2) Objectives of this Research Work
This study is conducted:
 To investigate as the profitability of the firm is influenced by the board size (BD)
of the firm.
 To evaluate whether the profitability of a firm is significantly affected by the
outside directors or NEDs proportion in CG.
 To assess whether Chief executive Officer or CEO duality has any influence on a
firm’s profitability.
3) Literature Review
3.1) Agency theory.
The relationship between principal and agent can be understood by implying agency theory
(Jensen and Meckling,1976). It is assumed that the agent will take care of the interest of its
principal without involving its own interest. Because the agent is the presenter of its principal
in the different transactions of a business (Noulas and Genimakis, 2011). In any firm,
resources are controlled by managers generally, but these managers are not the factual owners
and there is a chance of occurring conflict because sometimes there is a difference in
priorities of manager and shareholders (agent and principal), and one focused on their own
priorities even at the cost of others. The difference in priorities of manger and principals
causes conflict and leads to agency issues. According to Jensen and Meckling (1976) agency
theory determine a contract in which managers are hired by the shareholders and give them
the authority of decision making with the assumption that the managers work on the behalf of
their shareholders (Jensen and Meckling,1976). It can be stated that the manager is
responsible to maximize the wealth of their shareholders (Noulas and Genimakis, 2011). But
managers focus on their own priorities instead of focusing on the profit maximization of their
shareholders. Most of the time, the conflict has occurred at the time of financial decisions
making. Hence, the conflict has occurred between manger and shareholders which creates a
central theme of this agency theory (Bryant and Davis, 2012).
Moreover, disagreement between agent and principal leads to various problems and discord
within the company. This conflicting condition between management and principal causes the
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deficiencies and ineffectiveness of a firm’s performance and these agency issues not only
influence the firm’s operation but also impact the firm’s profitability (Chung and
Wang,2014).
Moreover, agency issues are significantly influenced by the firm size. Sajid (2012) argued
that an increase in a company’s assets leads to the effectiveness in the utilization of assets as
it became a relatively (Sajid,2012). Therefore, there is a need to accumulate the assets that
create chances of fraud by managers, and it increases the agency cost (Hamedah et al.2017).
On the other side, if managers have used the interest for their own interest and this incentive
is not found in the employment contract then it leads to moral hazards and creates conflicts
among managers and other shareholders (Zulvia and Serly,2020).
These conflicts can be minimized by developing a good Corporate Governance. Moreover,
some corrective measures can reduce these agency problems, for instance, the organization
maximizes the incentive of their managers for aligning the interest managers with the
shareholder’s interest (Brayant and Davic,2012). Furthermore, if the preferences of managers
are more aligned with their shareholder’s preferences, then it leads to an increase in firm
performance (Nazir and Afza,2018). There is an assumption that organizational performance
can be increased by aligning the interests/priorities of both parties (principal and agent).
Moreover, the firm value can be maximized by mitigating the agency problem (Chang and
Wang,2014).
3.2) Board Size
According to the theory of economics, the board of directors (BOD) plays a significant part in
Corporate Governance (Guillet et al.,2013). The shareholders have a concern about whether
the Board of directors has the capability to control or monitor to activities of managers in the
owner’s interest (Guillet, et al.,2013). The general perception is that a firm that has a large
board size can effectively supervise that ultimately improve the firm performance. Moreover,
it is also assumed that if there are many boards of directors then organizations have more
skilled and efficient people that affect the firm performance. According to Chung and Wang
(2014) there is a positive relation between in BD and financial performance of firm. Contrary
to this, Baptista et al., (2011) that the small board size presents improved performance as it
affects in different ways such as improved decision making and communication among the
organization (Baptista et al.,2011). Furthermore, the findings of the research conducted by
Bodaghi et al., (2010) suggested that the large board size has an inverse but minimal
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influence on organizational profitability (Bodaghi et al.,2010). Likewise, Guillet et al., (2013)
has conducted research on relationship among BD and organizational performance. The
findings of this study suggested that there is no improvement has been found due to the firm’s
large board size. But, contrary to this, it is revealed that there is significant influence has been
found on the profitability and overall performance of a firm by the board size of a
(Christensen et al., 2010).
3.3) CEO duality
Sometimes CEOs play two roles in some firms, they serve as the chief person of BOD as well
as executive managers (O'Connell and Cramer, 2010). Guidelines of Corporate governance
determine that if Chief Executive Officer is also playing the role of the chairperson, then
attain more power and strengthen the position of CEO (ASX Corporate Governance Council,
2007). CEO duality is one of the crucial and most debatable factors in CG. The advocates of
agency theory believe that the CEO duality negatively influences the firm’s profitability
(Jensen & Meckling, 1976; Fama & Jensen, 1983). But, contrary to this, advocates of
Stewardship theory believes that the CEO duality has a positive impact on form’s firm’s
(Motavassel,2013). Nazer (2012) stated that the duality of the Chief executive officer creates
a hindrance to the board’s independence that creates ineffectiveness in the governance
mechanism. But on the other side, it is discovered that the firm’s performance has improved
due to CEO duality. Because power is in hands of one person and it reduced the uncertainty
regarding the individual’s identity who is involved in the decision-making process
(Christensen et al., 2010). CEO Duality also known as chair duality, sometimes causes
agency issues (Jensen and Meckling, 1983). This conflicting situation directly influences the
financial mix of the organization. According to Fama and Jensen (1983) there is a difference
between the decision regarding management to the decision related to control function.
Management-related decisions are based on the formulation and execution of strategies and
decisions related to controlling function are based on monitor and approval of function. If the
firm could not manage its distinctiveness, then agency issues can be created. According to the
finding of a study conducted by Abor (2007) CEO duality has a significant positive influence
on the profitability of a firm (Abor,2007). Similar findings have been determined by
(Guillet,2013). But Contrary to this, Baptista (2011) argued that there is a negative influence
of CEO duality on a firm’s profitability (Baptista,2011).
3.4) Board Independence
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When there is an outside director (NED) who is the part of Board of Directors of the
organization but is not allowed to participate in the executive management of the firm. This is
called board independence. They are mostly known as external directors or independent
directors (Shahwan,2015). Independent directors have the authority to challenge the
executive directors as well as management performance (Bryant and Davis,2012). Moreover,
also took a stand for the protection of stakeholders and the company’s interest. These
independent directors depict that the organization is appropriately supervised and delivers
positive signals to investors as the firm is effectively and efficiently functioning (Wahyudin
and Solikhah, 2017). Agency theory determines that the independent board of directors can
more effectively monitor the management of a firm (Fama & Jensen, 1983; Christensen et al.,
2010). According Zulvia and Serly (2020) chances of fraud in the financial statement can be
minimized if independent directors are found in BOD (Zulvia and Serly, 2020).
Moreover, determines that some proportion of NEDs positively influence a firm’s share price
as well as profitability Similarly, Meah et al., (2019). argued that there is a significant
association between independent directors and the financial performance of the firm. The
findings of this study determined that they are open to disclosing the firm’s information
which leads to improving the performance of the firm (Meah et al.,2019). But Contrary to
this, Ashbaugh-Skaife et al., (2006) conducted research in which board composition is
evaluated and its effect is investigated on firm value. This research is conducted on the
Canadian firm. Findings of these studies determined that there is a negative relationship
between a firm’s value and board independence and the firm that encourages the NEDs has
lower performance as compared to the firm in which there is less or no proportion of NEDs
(Ashbaugh-Skaife et al.,2006).
4) Concluding Remarks
The main purpose of this study is to investigate the impact of CG on profitability.CG is
determined through its determinant such as BD, NEDs and CEO duality. By reviewing
literature on CG and its influence on profitability, it is revealed that there is a significant
impact either positive or negative. Very few studies suggested that there is not any impact of
CG on profitability.
Now, this current study is conducted on TESCO plc that will evaluate the impact of CG on
profitability by using the determinants of CG and EBIT/total asset for profitability.
Secondary data will be used, tables and graphs will be used to depict the result and regression
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analysis can be used to measure the impact of independent variables (CG) on dependent
variable (Profitability) with the use of Microsoft Excel and SPSS.
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