CORPORATE GOVERNANCE STRUCTURE AND FIRM PERFORMANCE IN SMALL AND MEDIUM-SIZED ENTERPRISES ( SMES ) IN SRI LANKA : A PATH TO ACCESS THE CREDIT

The purpose of this study is to analyse how the adoption of corporate governance structures affects the performance of SMEs in Sri Lanka. For this purpose, we examine the effect of board composition, board size, board and staff skill levels, board leadership (duality), and family ownership on firm performance. To obtain unbiased estimators for the effects of the independent variables, contextual factors such as firm age, firm size, and debt ratio are included as controls for corporate governance structure and performance relationships. Panel regression analysis is used to estimate the relationship between corporate governance and performance. The results show that all measures including board composition, board size, board and staff skill levels, board leadership (duality), and family ownership have significantly positive impacts on profitability. Corporate governance can greatly assist the SME sector by infusing better management practices. It is also clear that corporate governance structures influence the performance of SMEs in Sri Lanka. The finding also shows the implications of SMEs gaining access to finance as a result of adopting a good governance system.

However, most financial providers consider that financing SMEs is a risky business that generates high transaction costs and/ or low returns on investment (i.e.declining performance), and therefore hesitate to grant loans to potential clients in this sector.In fact, the World Bank's 2011 Investment Climate Assessment Survey in Sri Lanka, reveals that around 35 percent of Sri Lankan small firms can access a loan or a line of credit and around 14 percent of those who applied were denied financing.Therefore developing solutions to this major concern should be a top priority for most of the SMEs in Sri Lanka.

Lack of managerial competencies and proper
governance systems in the SME sector have been identified to swamp efforts at attracting such finance and thus are said to be the main barriers to SME development (Gockel & Akoena, 2002).It is necessary then for proper management of the SME sector to ensure enhanced performance, given that this would have major implications for financing opportunities for the sector.Therefore, we believe that the adoption of good governance practices among SMEs may assist them to come out from the present chaos that they encounter in Sri Lanka.Daily & Dalton (1992) found no relationship between CEO duality and performance in entrepreneurial firms.Brickley et al. (1997) showed that CEO duality is not associated with inferior performance.Rechner & Dalton (1991) also reported that companies with CEO duality have stronger financial performance relative to other companies.

Family ownership
It is often argued that the benefit of founding family leadership of firms is that family traits, such as trust, altruism and paternalism can create an atmosphere of love and commitment towards the business (James, 1999) and therefore curtail agency costs.Previous studies by James (1999) showed that founding family businesses provide special kind of corporate governance that offers lower agency costs and better performance.Other studies, however, indicated that entrepreneurs and managers of founding family firms are more likely to engage in managerial entrenchment to the detriment of the firm, resulting in weaker performance (Thomsen & Pedersen, 2000).

Empirical research: method, data and analysis
This study is subject to certain delimitation in order to reach a representative set of the population.First, the restrictions concerning the legal form of companies were imposed: we focused on limited companies and private limited companies as they have a legal obligation to establish boards of directors.
Second we excluded the companies affected by special situations such as insolvency, winding- Where Y it ,represents the firm's performance, X it is a vector of board factors, W it is a vector for the ownership variables, C it includes the set of control variables, α it is taken to be constant over time ''t'' and specific to the individual cross-sectional unit ''i'' and µ it is the error term in the model.Since performance is given as a function of both board and ownership characteristics, our model can be restated as: Our method of pooling cross-sectional and time series data is susceptible to heteroscedasticity.
We, therefore, checked for this problem using White heteroscedastic-consistent standard errors and covariance.To ensure the robustness of the model, we also include three control variables, size, age, and debt ratio to minimise specification bias.These are standard variables in performance models.

Descriptive summary statistics
The descriptive statistics for all the variables are presented in Table : 01

Regression
Claessens et al. (2002) say that better corporate governance frameworks benefit firms through greater access to financing, lower cost of capital, better performance and more favourable treatment of all stakeholders.Corporate governance brings new strategic outlooks through external independent directors; it enhances firms' corporate entrepreneurship and competitiveness (Abor & Adjasi, 2007).One of the key problems that have bedevilled the SMEs globally has been accessing to credit.The credit crunch and its accompanying dwindling of confidence resulting from the global financial crisis have shrunk bank lending, resulting in limited or no access to working capital for the SMEs.This inability to directly access the capital markets puts the SMEs at a competitive disadvantage relative to larger firms.Small and Medium-sized Enterprises (SMEs) continue to be central to the economic development of Sri Lanka.Pandula (2015) stated that around 80 percent of the businesses in Sri Lanka are considered to be SMEs.Additionally, SMEs contribute 50 percent to the Gross Domestic Production of the country and employ 26 percent of the labour force and have a value addition of 17 percent (Institute of Policy Studies & Oxfam International, 2014).
of directors are essential elements to most definitions of corporate governance.They bring out the formal link between owners and their managers responsible for the day-today operations of the SME.Most researchers agree that corporate boards are important to the accountability of corporations and the way corporations comply with modern ethical and economic standards.Thus, the significance of the board for SMEs cannot be over emphasised.However most SMEs, are closely held and owner-managed Corporate Governance Structure and Firm Performance in Small and Medium-Sized Enterprises (Smes) in Sri Lanka: A Path to Access the Credit Journal of Management -Vol.12 No.1 April 2015 and the owners usually do have direct and more insights into internal processes of the firm.Consequently, for most SMEs boards exist on paper only, the boards control function is non-existent.On the other hand, there are also instances of SMEs having active boards with outside members, where the board is used as an instrument of strategy development (Fiengener et al. 2005).The outside members usually view the tasks of the board as being clearly different and complementary to that of management, whereas insiders may view the board work as an extension of their managerial duties.The outside board members are not tied to the dayto-day activities of the SME and as a result, they are likely to think more freely regarding the strategic alternatives open to the SME (Forbes & Milliken, 1999).The debate on what should be the preferred board composition appear to tilt more favourably towards the board with more outside directors than inside.John & Senbet (1998) argue that boards of directors are seen to be more independent as the proportion of their non-executive directors increases.Rosenstein & Wyatt, (1990) and Brickley et al. (1994) supported that the market reward firms for appointing non-executive directors.In other words, an SME with more outside directors will be perceived more favourably by the market and financial institutions than SMEs with more inside directors.Board Size SMEs by their nature tend to have very smaller board sizes.Jensen (1993) argues that large boards are less effective and are easier for the CEO to control.When a board gets too big, it becomes difficult to coordinate and often creates problems.Smaller boards also reduce the possibility of free riding by and increase the accountability of individual directors.These arguments albeit there is still a strong case for SMEs to increase their board membership beyond the usual two to four.Transitioning from owner-manager to a company with a wide board is one of the most important transitions that an SME can undergo.This team approach permits clearer development and definition of the choices facing the business.Some researchers found a strong link between widened boards improved performance of SMEs (Wynarczyk et al., 1993).The result is even more impressive where there are more non-executive directors (Cowen & Osborne, 1993).Thus, SMEs with a larger board is more likely to have a better corporate governance environment than the ones with smaller ones.Board and staff skill levels Lybaert (1998) argues that better performance is due to the proven positive relation of higher levels of education among entrepreneurs and their willingness to use external information, develop networks, make use of consultants or develop more detailed accounting and monitoring.However, there is contrary evidence about the level of training among SMEs owners and managers.Lawrie (1998) demonstrates that gaps in management expertise are less of a recognised barrier to SME development than the availability of specialist staff skills, mainly IT and languages.Therefore, although higher-level management qualifications may be useful to SMEs, there is still some doubt as to their relevance.Powell (1991) maintains that there may even be a negative effect on firm performance as a result of the occupational and professional affiliations of highly qualified managers which may encourage increased agency behaviour.Board leadership (Duality) Another imperative aspect of dealing with when analysing the governance structure is the coincidence in the same person of the figures of the chairman and chief executive.Prior literature acknowledges that the type of board leadership and a role of the Chief Executive Officer (CEO) can have an influence on firm performance.A substantial body of research has focused on the association between firm performance and CEO leadership.The empirical evidence is no conclusive on CEO duality, and several studies even find no significant effect on firm performance.The Cadbury report (1992) state that the role of chairman should be separated from the role of CEO; if the two roles are combined in one person, it represents a considerable concentration of power within the decisionmaking process.It has been noted that the system where the CEO also acts as board chairman leads to leadership facing the conflict of interest and agency problems (Brickley et al., 1997) thus giving preference for the system where the CEO's role is separated from that of the board chairman.Yermack (1996) argues that firms are more valuable when the CEO and board chair positions are separate.Relating CEO duality more specifically to firm performance, researchers, however, found mixed evidence.
. The average profitability is 10, meaning the average return on assets stands at approximately 10 percent.Average board size for this sample of SMEs is about 04.The average board composition is given as 46 percent.The mean board skill is 02.This means, on the average there are 02 board members with the degree or professional qualification.The 92% of the SMEs have the CEO also actin as chairperson on the board.The results also indicate that our sample includes 73 percent family-owned businesses.The average value of the firms' assets is 43493.16Sri Lankan rupees and an average number of years the firms have been in business is 12 years.The average debt ratio is also shown as 38 percent.
gaining access to financing due to problems of, high transaction cost, information irregularities and lower return on investment.Ensuring proper accounting practices, internal control systems, adequate information disclosure is likely to increase the confidence of investors in the firm, reduce the problems associated with information irregularities and make the SME less risky to invest in.Small firms are particularly weak and often ignorant of sources of finance open to their firms.Most of the time, they do not know how to position themselves correctly to be viewed favourably by finance providers.The non-executive board members may have good knowledge or useful information on financing facilities.Thus, the existence of such directors could lead to better management decisions and help SMEs to attract better resources.Reference Abor, J., & Adjasi,C.K.D. (2007)."Corporate governance and the small and medium enterprises sector: theory and implications", International journal of business in society, 7 (2), 111 -122 Corporate Governance Structure and Firm Performance in Small and Medium-Sized Enterprises (Smes) in Sri Lanka: A Path to Access the Credit

Governance Structure and Firm Performance in Small and Medium-Sized Enterprises (Smes) in Sri Lanka: A Path to Access the Credit
up, or liquidation.Third, we eliminated listedCorporateSize is defined as the log of total assets.Age is the number of years between the observation year and the firm's year of incorporation.The debt ratio is the ratio of total debt to total capital.