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- 1. Impact of Corporate Governance on leverage and firm performance A study of firms listed on the Official Market in Mauritius A dissertation submitted to University Of Mauritius in partial fulfilment of therequirements for the degree of BSc (Hons.) Finance (Minor: Law), Faculty of Law and Management. Author: Hensley RAMOOGUR April 2013
- 2. ContentsList of tables..............................................................................................................................ivList of figures............................................................................................................................ivAcknowledgements....................................................................................................................v Project declaration form....................................................................................................viAbstract ....................................................................................................................................viiList of Abbreviations ............................................................................................................. viiiChapter 1: Introduction ..............................................................................................................1 1.1 Purpose of study...............................................................................................................2 1.2 Objectives of the study.....................................................................................................2 1.3 Potential Contributions of the study ................................................................................3 1.4 Delimitations of the study................................................................................................4Chapter 2: Literature Review.....................................................................................................5 2.1 Introduction of Corporate Governance in Mauritius .......................................................5 2.2 Theoretical Background...................................................................................................6 The Agency Theory ...........................................................................................................7 The Stakeholder Theory.....................................................................................................7 The Stewardship Theory ....................................................................................................8 2.3 Empirical background......................................................................................................9 2.3.1 Corporate governance and Capital structure.............................................................9 2.3.2 Corporate Governance and Performance of Firms .................................................10 2.4 Corporate governance Mechanisms ...............................................................................12 Ownership Structure ........................................................................................................12 Ownership concentration .................................................................................................13 Board Size........................................................................................................................13 Board Composition ..........................................................................................................14 CEO duality .....................................................................................................................14 ii
- 3. Audit Committee Independency ......................................................................................14 Disclosure of Stakeholders’ interests; Corporate Social Responsibility (CSR) ..............15Chapter 3; Research Methodology...........................................................................................16 3.1 Sample/ Research Design ..............................................................................................16 3.2 Independent and Controlling Variables .........................................................................17 3.3 Sources of data...............................................................................................................18 3.4 Proxies used ...................................................................................................................18 3.5 Model Specification .......................................................................................................19 The Multiple OLS Regression .........................................................................................20 Fixed versus Random Effects ..........................................................................................20 F-test for Fixed Effects ....................................................................................................21 Breusch-Pagan LM Test for Random Effects ..................................................................21 Hausman Test for Comparing Fixed and Random Effects ..............................................21Chapter 4; Data Analysis and Results......................................................................................22 4.1 Descriptive statistics ......................................................................................................22 4.2 Corporate Governance and capital structure..................................................................25 4.2.1 Correlation ..............................................................................................................25 4.2.2 Regression results and discussion...........................................................................27 4.3 Corporate Governance and Firm Performance ..............................................................34 4.3.1 Correlation ..............................................................................................................34 4.3.2 Regression results and discussion...........................................................................35 ROA as dependent ...........................................................................................................35 Tobin’s Q as dependent variable......................................................................................37 Altman Z Score as dependent variable ............................................................................39Chapter 5 Conclusion and Recommendation...........................................................................40List of References ....................................................................................................................42Appendices...............................................................................................................................48 iii
- 4. List of tablesTable 1: Number of firms in the sample _________________________________________16Table 2 List of independent variables ___________________________________________17Table 3: Dependent variables_________________________________________________18Table 4: Descriptive statistics _________________________________________________22Table 5: Correlation capital structure and corporate governance _____________________26Table 6: Regression results, capital structure and corporate governance _______________29Table 7 Multiple regression result: leverage and corporate governance ________________30Table 8 Correlation: Corporate governance and performance________________________34Table 9 Regression results: ROA and governance (Fixed Effect model) _________________35Table 10 Regression result for Tobins Q and governance ( OLS) ______________________37Table 11 Regression result; Altman Z Score and corporate governance ( OLS) ___________39List of figuresFigure 1 Hausman test for leverage and corporate governance .......................................................................... 54Figure 2 Fixed effects (within) estimation for leverage and corporate governance, including F-test................. 55Figure 3 OLS estimation for leverage and corporate governance ........................................................................ 55Figure 4 LSDV estimation for leverage and corporate governance ...................................................................... 56Figure 5 Random effects estimation for leverage and corporate governance ..................................................... 57Figure 6 LSDV estimation for roa and corporate governance............................................................................... 58Figure 7 regression, anova and VIF results for Tobins Q and corporate governance .......................................... 59Figure 8 regression, anova and VIF results for Altman Z Score and corporate governance ................................. 60 iv
- 5. Acknowledgements I gained a lot of experience and learnt a lot about the corporate world and itsprinciples when working my research. While browsing through annual report, I becamefamiliar to standard presentation and guidance of company’s financial statements. Also, Iunderstood the basics of corporate governance conduct and its importance which deterfraudulent act. Completing this dissertation was a formidable task of intimidating length andexacting expectations. Praise the lord on whom I always have faith. I am desirous for expressing my gratitude to my supervisor, Mr Mudhoo Dourgeswarwho has provided scholastic guidance, utmost cooperation, clues, reviews, feedbacks as well ascritical comments and suggestions to improve my work. His valuable guidance was vital forthe completion of my study. I am indebted to my parents and family who always encourage and influence me in allaspects of my life. I am also grateful to my best friends Girish, Keshav, Nivenda, Rajneesh,Urnesh and Sreshta who are always my best support. I am also thankful to Kunal and Vithiwho always had the words to cheer me up, for providing me all the necessary support andencouragement. Finally, I wish to express my feeling of gratitude to my fellow classmates. I have received much useful advice throughout the writing of my dissertation, but allthe faults that remain are obstinately my own. Lastly, I would like to dedicate thisdissertation especially to my grandpa and late grandma for both of them have showered theirlove in my upbringing. (Akshay Ramoogur) v
- 6. Project declaration form Digitally signed by Akshay Ramoogur DN: cn=Akshay Ramoogur gn=Akshay Ramoogur c=Mauritius l=MU e=aks_hay08@ho tmail.com vi
- 7. Abstract If companies are governed properly and the interests of all stakeholders are taken careof, a healthy corporate culture could be built. There exist very few research on this field inMauritius but yet is a concern. At the heart is the agency theory which according to Jensen, ifagency costs are reduced, the firm performs better and increases firm value. The theoryspecifically emphasises on board independence and CEO duality. Furthermore, varioustheories about corporate governance were developed but its effect on firm performance is notquite measurable. The purpose of the present study is twofold. First we have to producequantitative information about the present corporate governance system in Mauritius andcritically analyse it. Second, we have to investigate whether there is any relationship betweenfeatures of corporate governance and performance of listed firms in the Official Market ofThe Stock Exchange of Mauritius, and as such whether the agency problems is minimised inMauritius. A sample of 39 firms were analysed for the period 2007-2011. The ‘OwnershipStructure’, ‘Ownership Concentration’, ‘Board Independence’, ‘Board Size’, ‘IndependentAudit Committee’, ‘CEO duality’ and ‘Corporate Social Responsibility’ were considered ascore principles of corporate governance. Debt ratio was used to measure leverage and thelatter proved to have significant relationship with corporate governance. Performance wasmeasured by Return on Asset, Tobin’s Q and Altman Z-score. Various statistical models,including correlation, OLS multiple regression, fixed and random effect model were usedcoupled with appropriate tests. While most studies used a bivariate analysis, the studyemployed a multivariate analysis. Some findings were consistent while some have oppositeviews. The study answers some of past study questions like: what impact has corporategovernance created? (Implementation and Impact of Corporate Governance in Mauritius byMahadeo, J D and Soobaroyen, T ). Results indicate that the direction and the extent of impact ofgovernance are dependent on the performance measure being examined. Specifically, thefindings show that board equity, board size and size of the company affects performance.Keywords: corporate governance, capital structure, firm performance, agency cost, Mauritius vii
- 8. List of AbbreviationsBank of Mauritius (BoM)Central Depository, Clearing and Settlement System (CDS)Companies Act (Co. Act)Financial Services Commission (FSC)Global Business Companies (GBC)Institute of Directors (IOD)International Accounting Standards (IAS)International Accounting Standards (IFRS)Mauritius Institute of Directors (MID)National Committee on Corporate governance (NCCG)Net Present Value (NPV)Report on Code of Corporate Governance (RCCG)Organization for Economic Co-operation and Development (OECD)Stock Exchange of Mauritius Ltd (SEM) viii
- 9. Chapter 1: Introduction Corporate governance has a buzzword in the corporate world. It is the most happeningarea where several bodies across several countries are trying to improve the standards ofgovernance in corporate world. The other aspect which is required to be looked into iswhether standard of governance affect capital structure. As the research is on the corporategovernance related topic, before delving further on the subject, it is important to dwell uponthe concept of corporate governance. According to James Wolfensohn former World BankGroup President, corporate governance is about promoting corporate fairness, transparencyand accountability (Financial Times, 1999). Effective governance practices decreases ‘controlrights’ of managers which are conferred by the shareholders and creditors. This increases thelikelihood of managers investing in positive net present value projects (Shleifer and Vishny,1997). These are foremost to protect the interests of shareholders. Governance is a requisitefor survival and a gauge of how predictable the system for doing business in any country is.While public attention towards the importance of corporate governance gained momentumonly after the unearthing of major scandals such as Enron(2001)1, AOL(2002), TycoInternational (2002), World Com(2002), and Satyam Computer Services(2009) and morerecently Lehman Brothers (2010) where Ernst & Young ( the Audit firm) fail to discloseRepo 105 transactions to investors. These scandals have stressed the need and usefulness forproper analysis of financial statements of companies using different tools so as to detect andavoid these collapses and to help investors in their investment decisions. It would be wrong toassume that the concept of corporate governance is something new; the need for strongcorporate governance arose at about the same time as the ownership and management ofcorporate entities were separated and the application of agency theories set in as will bediscussed later in details in literature chapter.1 The ENRON Scandal is considered to be one of the most notorious within American history. ENRONscandals; deregulation, misrepresentation, fraudulent energy crisis, embezzlement. Due to the actions of theENRON executives, the ENRON Company went bankrupt.
- 10. 1.1 Purpose of study Following these corporate failures and scandals, the last two decades witnessed anincreasing intensity of researches on corporate governance. Firms with weaker standards tendto face more agency problems which weaken their foundation for better performance.Furthermore, it helps management in decisions like board compositions, mergers andacquisitions. There are many researches which targeted the effect of CEO duality, BoardSize, Board Balance, Ownership, and Board Dedication on Firm’s Performance and capitalstructure, but few on in Mauritius. Capital structure decisions are some of the core decisionsof today’s businesses. The inclusion of debt in the capital structure may affect the overallperformance and market value of the company. This research will provide the policy makerswith insight to the type of corporate governance which may ensure an optimal capitalstructure. This study tries to analyze the different variables of corporate governance to find outtheir impacts on financial performance and find whether there is relationship betweengovernance and performance.1.2 Objectives of the study The goal of this research is twofold. First, it gathers, for the first time, quantitativemeasures of the corporate governance and performance ratios of companies in Mauritius. Awide array of official and private sources was used for this research. Second, we test thepredictions of recent theories based on theoretical framework and hypotheses. There aremany researches which targeted the effect of CEO duality, Board Size, Board Balance,Ownership, and Audit on Firm’s Performance on developed and emerging countries.(Note that the analysis will break into two parts: corporate governance and capital structure,and, corporate governance and firm performance explaining ‘/’ in the hypotheses)H1: There is a significant relationship between ownership structure and firms capitalstructure / firm performanceH2: There is a significant relationship between ownership concentration and firms capitalstructure / firm performance 2
- 11. H3: There is a significant relationship between board size and firms capital structure / firmperformanceH4: There is a significant relationship between board independence and firms capitalstructure / firm performanceH5: There is a significant relationship between independent audit committee and firmscapital structure / firm performanceH6: There is a significant relationship between CEO duality and firms capital structure / firmperformanceH7: There is a significant relationship between social responsibility and firms capitalstructure / firm performance1.3 Potential Contributions of the study This study contributes to the existing literature through many sites which may beelaborated, as follows:1- A practical based, practitioner’s suggested, and corporate governance variable for adeveloping sector is the core achievement of this study.2- Inclusion of a separate factor of corporate governance in capital structure is the othermajor contribution of this study.3- There are few researches on corporate governance and firm performance in Mauritius, andI intend to provide scope for the study with corporate variables whilst others followed thescorecard approach. 3
- 12. 1.4 Delimitations of the study Despite of some efforts, there are several limitations of this study; they can bementioned as under:1. The study is conducted mainly by depending upon the secondary sources of information2. The corporate governance study is calculated by calculating a specific variable for eachcorporate governance element which has a scope for further research.3. Limitations of Financial Statement AnalysisFinancial statement analysis is widely used but it has two major drawbacks. Firstly itinvolves the comparability of financial data between companies and secondly the need tolook beyond ratios.4. The study was delimited to the period of 2007 to 2011.5. The inclusion of all sectors in the same sample did make data interpretation difficult inChapter 4. 4
- 13. Chapter 2: Literature Review2.1 Introduction of Corporate Governance in Mauritius Among African companies, corporate governance is often regarded as a weak link toperformance. Mauritius has adopted a more or less a free market economy as economicmodel. Private investment is the heart of the system. Government provide incentives andinfrastructure through various forms and sets the rules. Basic finance theory differentiatesbetween those having an excess of money and those in need of money. Savings can be both atindividual and at institutional level. A system of corporate governance is vital to keep thebalance between the interests of the investors (individuals and institutions), the entrepreneur(and his family), the management and other stakeholders, as does the sustainability of thebusiness. Governance was an issue in Mauritius as elsewhere for many years. However, itwas in 2001 that Mr Sushil Kushiram, the then Minister of Finance, Economic Developmentand Financial Services, and his government decided, it was time to create a legal andinstitutional framework to enhance corporate governance and as part of the modernization ofthe Mauritian Economy From 2001, began a number of reforms, laws were revised and new laws were enactedand also institutions were set up. The Committee of Corporate Governance came to birth andthe Minister asked Mr Tim Taylor to chair it; the Listing Rules of the SEM were reviewed; anew Companies Act was passed and International Accounting Standards (IFRS) wereintroduced. Mauritius has taken the lead in lending institutional support to corporategovernance. The National Committee on Corporate Governance (NCCG) was created underthe aegis of the Financial Reporting Act2, and in turn this spawned the creation of theMauritius Institute of Directors. The process continued and the Securities Act, the InsuranceAct and the Insolvency Act were passed. In 2001, the Financial Services Commission3 wasset up, The NCCG, with the help of Prof. Mervyn King, published the Code of CorporateGovernance 4in 2003, and also issued “Guidance Notes for State-Owned Enterprises” in2006. In 2009, the “Statutory Bodies (Accounts and Audit) Act” was amended to make it2 THE FINANCIAL REPORTING ACT 2004: S63-71 :PART V - THE NATIONAL COMMITTEE ONCORPORATE GOVERNANCE3 FSC regulates and licenses financial and non-banking activities in Mauritius4 The Report comprises eight sections dealing with - (i)Compliance and Enforcement, (ii) Boards andDirectors, (iii) Board Committees, iv) Role and Function of the Company Secretary, (v) RiskManagement, Internal Control and Internal Audit, (vi) Auditing and Accounting, (vii) IntegratedSustainability Reporting, and (viii) Communication and Disclosure. 5
- 14. compulsory for statutory bodies to include in their annual reports a corporate governancereport in accordance with the National Code of Corporate Governance, this being effective asfrom 2011. Mauritius is often referred to for its economic success story. Many economists andother researchers have marvelled at the spectacular transformation of the country. Ali Zafar,macroeconomist at the World Bank pointed out in a recent report5 that this was due to acombination of political stability, strong institutional framework, low level of corruption, andfavourable regulatory environment. Not surprisingly these fundamentals are reflected ingovernance indices like the Mo Ibrahim Index, which for three consecutive years rankedMauritius as first in Africa. It is difficult to say whether the Mauritian miracle can beattributed solely to good governance, but when contrasted with many other countries,including the highly developed ones, it is quite tempting to believe that this may well be thecase. The financial crisis has been attributed, not only to a failure of the state level to manageand control systemic economic risks through timely policies and regulations but also poorcorporate governance..2.2 Theoretical Background There is no such accepted theoretical base for corporate governance, (Carver, 2000;Tricker, 2000; Parum, 2005; Larcker,; Harris and Raviv, 2008). Citing Pettigrew (1992),Tricker (2000) and Parum (2005) argued that corporate governance research lacks coherence;either is theoretically, empirically or methodologically since the modern organisation iscomplex. Per se, a number of alternative frameworks for corporate governance came to lightfrom different disciplines like economics, management and even psychology and sociology.There are three well known corporate theories/frameworks namely the Agency Theory (from1930’s onwards), the Stakeholder Theory (from 1970’s onwards) and the StewardshipTheory (from the 1990’s onwards). Using various terminologies, these frameworks viewcorporate governance from different perspectives. However, these frameworks often overlaptheoretically and do share significant commonalities (Solomon and Solomon, 2004)6.5 Mauritius: An Economic Success Story, January 20116 For example, agency theory and transaction-cost economics share key assumptions and approaches inconceptualizing boards (Stiles and Taylor, 2002), and it is often difficult to clearly distinguish between theconcept of stewardship and trusteeship (Learmount, 2002). 6
- 15. The Agency Theory Emanating from the classical thesis on The Modern Corporation and Private Property byBerle and Means (1932), this model was developed by Jensen and Meckling (1976) andfurther by Fama and Jensen (1983).It is perhaps starting point and the most known model.The theory surges to explain the agency problem and the costs associated with it. Thediscussion about the need for improving the governance of the firms is a response to manycases of expropriation of shareholders’ wealth by the top executives, but also by the majorityshareholders at the expense of the minority shareholders. This phenomenon describes quitewell the agency problem, when the agents take decisions maximising their own interestsrather maximising shareholder’s value (the same apply to the appropriation by the majorityshareholders of the private benefits of control). Solutions to agency problems involveestablishing a ‘nexus’ of optimal contracts (explicit as well as implicit) between the ownersand management of the company. The key issues towards addressing opportunistic behaviourfrom managers within the agency theory are board independence and CEO duality. It is arguedthat this reduces conflict of interest and ensures a board’s independence in monitoring andpassing fair and unbiased judgement on management. CEO duality reduces the concentration ofpower in one individual and thus greatly reduces undue influence of particular management.The Stakeholder Theory By expanding the spectrum of interested parties, the stakeholder theory stipulates that, acorporate entity invariably seeks to provide a balance between the interests of its diversestakeholders in order to ensure that each interest constituency receives some degree ofsatisfaction (Abrams, 1951). The stakeholder theory therefore encloses creditors, customers,employees; banks, governments, and society are regarded as relevant stakeholders. Related to theabove discussion, John and Senbet (1998) emphasize the role of non-market mechanisms such asthe size of the board, committee structure as important to firm performance. Stakeholder theory has infiltrated the academic dialogue in management and a widearray of disciplines. Much attention has been paid to some basic themes that are now familiarin the literature – 1.that firms have stakeholders and should proactively pay attention to them(i.e., Freeman, 1984), 2.that stakeholder theory exists in tension (at least) with shareholdertheory (i.e., Friedman, 1970), 3.that stakeholder theory provides a vehicle for connectingethics and strategy (i.e., Phillips, 2003), and 4.that firms that diligently seek to serve theinterests of a broad group of stakeholders will create more value over time (i.e., Campbell, 7
- 16. 1997; Freeman, 1984; Freeman, Harrison & Wicks, 2009). However, there are so manydifferent interpretations of basic stakeholder ideas that theory development has been difficult(Scherer & Patzer, 2011). An extension of the theory called an enlightened stakeholder theorywas proposed. However, problems relating to empirical testing of the extension have limited itsrelevance (Sanda et al., 2005).The Stewardship Theory Relative to agency theory, stewardship theory has received limited attention as atheoretical model for explaining the relationship between firm managers and firm owners.Human beings are seen as self-interested, opportunistic, utility maximisers whose primaryfocus is economic benefit (Jensen and Meckling 1976). According to the stewardship theory, amanager’s objective is primarily to maximize the firm’s performance because a manager’s needof achievement and success are satisfied when the firm is performing well. A tension betweenprincipal and agent occurs as both parties cannot maximize their economic utility in theprincipal-agent relationship. Stewardship theory addresses the underlying agency theoryassumption that there is a tension between the risk propensity of principals and their agentswhereby agents focus their actions upon mitigating their personal risk at the expense ofprincipals. Stewardship theory assumes that managers behave as trustworthy stewards of theorganization and focus on the collective good of the constituents in the firm regardless of themanager’s self-interests (Davis et al. 1997, Donaldson and Davis 1991). The stewardship theory considers the following summary as essential for ensuringeffective corporate governance in any entity: 1. the involvement of non-executive directors(NEDs) is viewed as critical to enhance the effectiveness of the board’s activities, 2. the positionsof CEO and board chair should be concentrated in the same individual. The reason is that itaffords the CEO the opportunity to carry through decision quickly without the hindrance of unduebureaucracy. 3. Small board sizes should be encouraged to promote effective communication anddecision-making even though it fails to find an optimal ‘small’ board size? Nevertheless, none of the above theories or frameworks offers a clear picture of theexact direction of the causality between governance and capital structure nor firmperformance. Governance theories suggest that strong shareholder rights can mitigate agencyproblems and, as a consequence, increase firm value. However, shareholders rights can berestricted by the managers. Therefore, no causal inferences can be drawn from the theory 8
- 17. since it is not clear that there is a causal relationship and its direction. Due to this lacuna inthe theoretical framework, many researchers have been showing empirically that governancedrives performance. However, they point out the limitations of their results warning that theymay not be robust to some unobservable firms’ characteristics. In the sequence, an empiricalreview on the field of corporate governance is provided, giving special attention to therelationship between governance and performance.2.3 Empirical background2.3.1 Corporate governance and Capital structure This study has been conducted with the hypothesis that a relationship may existbetween corporate governance and capital structure. The selection of capital structure is atopic which has been under discussion for a long period of time. Modigliani and Miller(1958) propounded a theory of capital structure, known as MM theory, which states that thereis no optimal capital structure because each structure is based on different assumptions likeperfect a market, no taxes, etc. After their research, a lot of researchers in the world tried tofind out different determinants of capital structure. (Kim & Berger (2008) and Toy et al.(1974) found growth, profitability, and international risk as the determinants of capitalstructure. After this study, firm size, industry class, business risk, and operating leveragewere tested by Ferri and Jonnes (1979) as the possible determinants of capital structure.Titman and Wessel (1988) found profitability having negative relationship with capitalstructure. They also found that small firms rely on short term financings. Laporta at al. (1998)worked to find out why firms have different financing behavior in different countries andfound that different legal protection in different countries explains the firms’ financingbehaviors. In a country where legal protection is weak, the chances of agency conflictincreases. In this situation, leverage can play a role to alleviate the agency cost betweenmanagers and shareholders (Grossman and Hart, 1982). Various research studies have also tried to find out the effect of ownership structure indetermination of optimal capital structure. Slutz (1988) developed a model for firms’ targets,capital structure, and ownership structure. Extensive research is found on different corporategovernance characteristics with capital structure decisions (Wen, Rwegasira and Biderbeek(2002). Jiraporn and Liu (2008) conducted a study to find the relationship between a 9
- 18. staggered board and capital structure. They found that the companies which have a staggeredboard are less leveraged than the other boards. Berger et al (1997) conducted a study to findthe relationship between board size and capital structure decision and found that there is anegative relationship between board size and leverage and also found a positive relationshipbetween the presences of outside directors on boards with debt in the capital structure. Lipton& Lorsch (1992) argued that there is a significant relationship between board size and capitalstructure. Jensen (1986) found that big boards have larger debt in their capital structure..Managerial equity proportion has also been studied by various researchers and both positiveand negative evidence has been found with capital structure. Agrawal and Mandelker (1987)and Amihud et al. (1990) found a positive relationship between these two variables, whileFriend and Hasbrouk (1998) found a negative relationship between these two variables.2.3.2 Corporate Governance and Performance of Firms A recent study was carried by Lamport M J, Latona M N, Seetanah B and SannasseeR V on the impact of corporate governance on firm performance in Mauritius. The study usedTaffler Z-score as proxy for performance and calculated a corporate governance score. Theyfound no significant relationship between corporate governance and firm performance.However this alone cannot conclude the hypothesis. No more such study are found forMauritius. A number of studies exist though about the implementation of corporategovernance. Thus, the study will also attempt to answer this hypothesis. Empirical studies from various countries are abundant. Some researchers had lookedfor a direct evidence of a link between corporate governance and corporate performancewhile other researchers have tried to study the correlation between the corporate governanceand firm’s performance. Much of the previous literature has shown a positive relationship(Brickley et al, 1994; Brickley and James, 1987; Byrd and Hickman, 1992; Chung et al,2003; Hossain et al, 2000; Lee et al, 1992; Rosenstein and Wyatt, 1990; Weisbach, 1988)between governance and firm performance assuming that governance is an independentregressor, i.e. it is exogenously determined, in a firm performance regression. This wouldsuggest that firms are not in equilibrium, and improvements in governance would lead toimprovements in firm performance. On the other hand, other studies have reported negativerelationship between corporate governance and firm performance (Bathala and Rao, 1995;Hutchinson, 2002) or have not found any relationship (Park and Shin, 2003; Prevost et al.2002; Singh and Davidson, 2003; Young, 2003). Demsetz and Lehn (1985). 10
- 19. Several explanations have been given to account for these apparent inconsistencies.Some have argued that the problem lies in the use of either publicly available data or surveydata as these sources are generally restricted in scope. It has also been pointed out that thenature of performance measures (i.e. restrictive use of accounting based measures such asreturn on assets (ROA), return on equity (ROE), return on capital employed (ROCE) orrestrictive use of market based measures (such as market value of equities) could alsocontribute to this inconsistency (Gani and Jermias, 2006). Furthermore, it has been arguedthat the “theoretical and empirical literature in corporate governance considers therelationship between corporate performance and ownership or structure of boards of directorsmostly using only two of these variables at a time” (Krivogorsky, 2006). For instance,Hermalin and Weisbach (1991) and McAvoy et al. (1983) studied the correlation betweenboard composition and performance, whiles Hermalin and Weisbach (1991), Himmelberg etal. (1999), and Demsetz and Villalonga (2001) studied the relationship between managerialownership and firm performance. To address some of the aforementioned problems, it is recommended that a look atcorporate governance and its correlation with firm performance should take a multivariateapproach. The present study adds to the literature by employing both market based andaccounting based performance measures such as return on assets and Tobin’s Q and test therelationship between them and selected governance variables. In addition to boardcharacteristics, we also include board activity intensity as well as audit committee practicesand characteristics, social responsibility as an extended arm of governance. We combinesurvey and publicly available governance data to broaden the scope of governance variables. 11
- 20. 2.4 Corporate governance Mechanisms Recent studies have used different kind of approaches to measure corporategovernance. Fundamentally, each research possesses its own way of evaluating corporategovernance, some constructed indices, and others calculated corporate governance absolutevariables. For example Klapper and Love (2004) evaluate the differences in the governancepractices of 14 companies in emerging markets through the use of a corporate governanceindex developed by the Credit Lyonnais Securities Asia (CLSA), an investment bank.Gompers Ishii and Metrick (2003) used different provisions to construct an index. The present study will attempt to use rather a variable for each corporate governanceitem. Each item/variable is assessed as used in previous researches in this field of study. Thisis further elaborated below and in chapter 3(see table xxx). In this study, the researcher’scorporate governance variables are Ownership structure, Ownership concentration, Boardsize, Board independence, Audit Committee independency, CEO duality, and finally Socialresponsibility. The following literature provides a summary.Ownership Structure Ownership structure has been under extensive discussion for a long time. Severalauthors have given reasons for the difference in this ownership structure. Sun and Tong(2003) indicated that different kind of ownership exists: legal ownership, employeeownership, board ownership institutional ownership, and public ownership. Structure wasmeasured by board ownership as conducted by Eric Sevrin (2001). Jensen and Meckling(1976), Fama and Jensen (1983) and Shleifer and Vishny (1986), among others, havesuggested that the structure of equity ownership has an important effect on managerialincentives and firm value. Kim and Sorenson (1986), and Agrawal and Mandelker (1987) forAmerican firms; Friedman et al. (2003) for Asian firms; Boubaker (2007) for French firms;and Holmen et al. (2004) for Swedish firms all find evidence of a positive relationshipbetween debt and control. 12
- 21. Ownership concentration Ownership concentration will be identified as major 10 shareholders of a company orholding equivalent of 5% or more of the outstanding shares. Shlifer and Vishney (1997)analysed how ownership concentration is one of the important determinants of corporategovernance. Several views of ownership concentration are found in the literature. Some say itis good, and Johnson et.al (2000) evaluated ownership concentration as a source oftunnelling; large shareholders become the managers and cause serious agency problems forminority shareholders. Laporta et al. (1999, 2002) regarded ownership concentration as oneof the big agency problems in the countries where legal protection is weak. Most priorevidence shows that firms with high ownership concentration have higher leverage levels(Grossman and Hart, 1986; Anderson et al., 2003). Controlling shareholders prefer debt toequity financing, since they tend to maintain their level of voting control for a given level ofequity. Again mixed results were found as discussed above.Board Size Limiting board size to a particular level is generally believed to improve theperformance of a firm because the benefits by larger boards of increased monitoring areoutweighed by the poorer communication and decision making of larger groups. Empiricalstudies on board size seem to provide the same conclusion: a fairly clear negative relationshipappears to exist between board size and firm value (Rouf , 2011). Lipston and Lorsh (1992)and Jensen (1993) also indicate that the larger board is less effective. Berger et al.(1997)found that larger board of directors result in low leverage levels. Dalton and Dalton(2005)found superior performance resulted from larger boards while Hermalin and Wiesbach (2003)and Bhagat and Black (1999) proposed an opposite view. 13
- 22. Board Composition A board is more independent if it has more non-executive directors (NEDs). As tohow this relates to firm performance, empirical results have been inconclusive. In onebreadth, it is asserted that executive (inside) directors are more familiar with a firm’sactivities and, therefore, are in a better position to monitor top management. On the otherhand, it is contended that NEDs may act as “professional referees” to ensure that competitionamong insiders stimulates actions consistent with shareholder value maximization (Fama,1980). Some studies find better performances for firms with boards of directors dominated byoutsiders (Jensen 1986, Berger et al 1997 and Abor 1997), while Weir and Laing (2001) andPinteris (2002) find no such relationship in terms of accounting profit or firm value. Also,Forsberg (1989) find no relationship between the proportion of outside directors and variousperformance measures. In the same vein, Hermalin and Weisbach (1991) and Bhagat andBlack (2002) find no correlation between the degree of board independence and fourmeasures of firm performance.CEO duality Several studies have examined the separation of CEO and chairman of the board,positing that agency problems are higher when the same person occupies the two positions.Using a sample of 452 firms in the annual Forbes Magazine rankings of the 500 largest USApublic firms between 1984 and 1991, Yermack (1996) shows that firms are more valuablewhen the CEO and the chairman of the board positions are occupied by different persons.Sanda et al (2003) found a positive relationship between separate CEO and chairmanpositions and firm’s performance while Abor (2007) concluded that there is a positivecorrelation between CEO duality7 and capital structure and Rechner and Dalton (1991) foundthat firms with CEO duality performed better while.Audit Committee Independency The audit committee also plays an important role in the improvement of firm value byimplementing corporate governance principles. The principles of corporate governancesuggest that the audit committee should work independently and perform their duties withprofessional care. The audit committee monitors mechanisms that improve quality of7 CEO duality; when the positions of Chairman and CEO are held by the same person. 14
- 23. information flows between shareholders and managers (Rouf, 2011, p.240), which in turn,help to minimize agency problems. Most empirical works like Ho 2005 have revealedpositive findings whilst some, like Brown and Caylor (2005), have concluded that thesignificance of the relationship lies between audit quality and dividend yield and not withoperating performance. Klein (2002) reports a negative correlation between earningsmanagement and audit committee independence. Anderson, Mansi and Reeb (2004) find thatentirely independent audit committees have lower debt financing costs.Disclosure of Stakeholders’ interests; Corporate Social Responsibility(CSR) Corporate social responsibility is the commitment of business to contribute tosustainable economic, development, working with employees, their families, the localcommunity and society at large to improve their quality of life. Therefore, ethical deedswould send the correct signal to the different stakeholders and impact on performance. Forexample, Ho (2005) illustrated in his survey that firms perform better than without thesesfundamentals In a study by Hackston and Milne (1999), it was seen that New Zealandcompanies make most social disclosures on human resources, with environment andcommunity themes also receiving significant attention. . In summary, the empirical studies reveal mixed views about the relationship betweengovernance and performances. Unfortunately, generalizability of such findings may notextend across national boundaries due to different regulatory and economic environments,cultural differences, the size of capital markets and the effectiveness of governancemechanisms. 15
- 24. Chapter 3; Research Methodology This chapter contains a description of the methodology of the study which coversPopulation, Sample, List of variables, Data collection, model specification and the proxiesthat were used. Panel data methodology was adopted because it combined time series andcross sectional data. The method of analysis is multiple regression, fixed and random effectsmodel.3.1 Sample/ Research Design The data used for this study were derived from the audited financial statements of thefirms listed on the official market for the year 2007-2011. The sample of the firms wereselected using the combination of non- probability sampling technique (firms with therequired information; were initially selected) and stratified random technique (firms werethen selected based on their sectorial classification) while some sectors were excluded 8. Atotal of 39 firms (see Appendix A) were finally used as sample as shown in the table below. SECTOR Number of firms Banks & Insurance and other finance 7 Commerce 5 Industry 8 Investments 12 Leisure & Hotels 4 Sugar 2 Transport 1 Total: 39 Table 1: Number of firms in the sample8 The following sectors were excluded from the sample because of their complicated regulations; debt, foreign,global and specialised firms, specialised debt securities , global business companies. 16
- 25. 3.2 Independent and Controlling Variables To increase the confidence of the results, there are set of controls variables which areincluded in the regressions. The study expects firm size may have a negative effect if size iscorrelated with the exhaustion of growth opportunities, but may contrarily have a positiveimpact whenever size is correlated with more diversification, greater economies of scale andscope, more professionalized management, and less severe financial constraints. Sales growthis a proxy for the product demand faced by the firm and its productivity. Therefore to account for these, additional independent variables were added otherthan corporate governance elements, to the model as shown in the table below. Independent Variables Abbreviations Description Ownership structure OS Shares held by board of directors/ Total no. of shares outstanding, following Eric Sevrin (2001), Ownership concentration OC Shares owned by top10 shareholders/ Total no. of shares following Lin Chen et. al (2008) Board Size BS Ln of total No. of Board members Board Independence BI NED/ Total No. of Directors in Board) being in line with Kee et al (2003), Lin Chen (2008) Audit Committee ACI Non-Executive directors in Audit committee/ Independence Total No. of Directors in Audit Committee) following Forker’s (1992) CEO Duality CEOD Whether CEO and Chairman is the same person. Sales Growth SG Current sales minus previous years sale/ previous years sale following signalling theory Return on Equity ROE Net Profit/ Shares Holders equity. Size of the firm Size Ln of total Assets following Scott and Martin (1975) Table 2 List of independent variables 17
- 26. 3.3 Sources of data To be able undertake our research, we must collect the maximum data available, thatis qualitative and quantitative data. We cannot concentrate on only one sort of data. First ofall I derived a list of all companies since the population of listed companies is small; most ofthe firms were selected apart from the debt and GBC sector because of their specificregulations. Also, eliminate all utility and affiliates of foreign firms. Data on required variables is collected through primary and secondary sources. Datawere collected through self-administrated survey, mail survey, interviews and annual reports(2007-2011). The Stock Exchange of Mauritius website and individual companies’ websitewere extremely useful.3.4 Proxies used Variable Abbr. Description Capital structure measure Leverage ( Market value) LevMV Total debt/(Total debt+ MV of shareholder’s equity) Firm Performance measure Return on asset ROA Profit after tax/ total asset Tobin’s Q Q Total market value of firm/ total asset value Where Total market value of firm= equity market value + book value of debt Since market value of debt is not publish. Altman Z-score AltZ See Appendix B Table 3: Dependent variables 18
- 27. Leverage will be used as a proxy for capital structure. ROA will be used as anindicator for profitability and efficiency. Tobin’s Q selection as a ratio to measure firm value,as employed by previous studies mentioned in literature part. Altman Z Score was used as aproxy for financial health of the company. It is an improvement of the debt ratio in the sensethat it takes into account the current liquidity position held by the company. This scorecalculated by five ratios:1. Liquidity on total assets2. Sales to total assets3. Equity to debt4. Working capital to total assets5. Retained earnings to total assets Altman Z Score is the summation of these ratios multiplied by a predeterminedweight factor. Score above 2.99 are considered to be financially sound, while those scoringbelow 1.81 are in fiscal danger, maybe even heading toward bankruptcy. Therefore, scoreswithin the range 1.81-2.99 indicate potential trouble (See Appendix B for more details).3.5 Model Specification Given well-organized panel data, panel data models are definitely attractive andappealing since they provide ways of dealing with heterogeneity and examine fixed and/orrandom effects in the longitudinal data. Our model is a micro panel (N is large and T is lessor equal to 5 years). However, panel data modelling is not as easy as it sounds. We should notrush in just choosing fixed effect model or random effect model. Carelessness could lead towrong interpretation and inappropriate modelling.In our empirical panel data, we are concerned about choosing between three alternativeregressions. This choice is between Ordinary Least Squares method, fixed effects (or within,or least squares dummy variables) estimation and random effects (or feasible generalizedleast squares) estimation. A series of tests are carried to test for fixed and random effects in 19
- 28. the model and appropriate model will then be fitted. The F-test for fixed effects, Breusch-Pagan LM Test for Random Effects and Hausman Test for Comparing Fixed and RandomEffects.The Multiple OLS Regression A multiple OLS regression is concerned with the relationship between a dependentvariable and a series of independent variables. The multiple regression allows the analyst tocontrol for the multiple factors that simultaneously affect a dependent variable. The followingrepresents the relationships in our model = + + + + + + + + + + eit , where Y is the dependent variable and the assumptions of linearity, reliability ofmeasurement, homoscedasticity, and normality and no autocorrelation (Gauss-MarkovTheorem).Fixed versus Random Effects The distinction lies in how the parameter estimate of the dummy variable is treated. Itis a part of the intercept in a fixed effect model while an error component in a random effectmodel. Slopes remain the same across group or time period in either fixed or random effectmodel. The functional forms of one-way fixed and random effect models are Fixed effect model: y ( ui ) X it vit Random effect model: y X it ui vit , where i u is a fixed or random effect specific to individual (group) or time period thatis not included in the regression. 20
- 29. F-test for Fixed Effects In a regression of Y X it , the null hypothesis is that all dummyparameters except for one for the dropped are all zero, : H0: … . The alternative hypothesis is that at least one dummy parameter is not zero. Thishypothesis is tested by an F test, which is based on loss of goodness-of-fit. This test contrastsLSDV (robust model) with the pooled OLS (efficient model) and examines the extent that thegoodness-of-fit measures (SSE or R2) changed. If the null hypothesis is rejected (at least onegroup/time specific intercept ui is not zero), you may conclude that there is a significant fixedeffect or significant increase in goodness-of-fit in the fixed effect model; therefore, the fixedeffect model is better than the pooled OLS.Breusch-Pagan LM Test for Random Effects Breusch and Pagan’s (1980) Lagrange multiplier (LM) test examines if individual (ortime) specific variance components are zero, H0: The LM statistic follows the chi-squared distribution with one degree of freedom. If thenull hypothesis is rejected, you can conclude that there is a significant random effect in the paneldata, and that the random effect model is able to deal with heterogeneity better than does thepooled OLS.Hausman Test for Comparing Fixed and Random Effects How do we know which effect (fixed effect or random effect) is more relevant andsignificant in the panel data? The Hausman specification test compares fixed and random effectmodels under the null hypothesis that individual effects are uncorrelated with any regressor in themodel. Hausman test examines if “the random effects estimate is insignificantly different fromthe unbiased fixed effect estimate” (Kennedy, 2008). If the null hypothesis of no correlation isrejected, you may conclude that individual effects ui are significantly correlated with at least oneindependent variable in the model and thus the fixed effect model is preferred. 21
- 30. Chapter 4; Data Analysis and ResultsNote: Raw data used in this study can be found in Appendix C.4.1 Descriptive statistics Variable Mean Std. Min Max Percentiles Skewness Kurtosis Dev. 50% 75% os 0.09 0.14 0 0.69 0.2444 0.1167 2.5561 9.5855 oc 0.61 0.221 0.12 0.9 0.6979 0.7855 6.8495 47.9520 bs* 10.381 0.190 7.029 15.029 11.0000 12.0000 -0.3006 2.4542 bi 0.78 0.11 0.29 0.93 0.8182 0.8462 -2.0272 9.1234 aci 0.94 0.11 0.67 1 1 1 -1.6247 3.9341 ceod 1 0 0 1 1 1 -5.5110 31.3643 csr 14.51 1.87 9.25 18.56 14.2393 15.9909 -0.1949 2.7429 sg 0.2 1.09 -1 10.56 0.1029 0.1915 -1.1589 9.0235 roe 0.15 0.23 -0.11 1.93 0.0892 0.1789 5.5249 37.5252 size 22.52 1.79 16.29 26.24 22.7659 23.4938 -0.7716 4.5833 levmv 0.24 0.24 0 0.92 0.1763 0.3425 1.3031 4.1188 roa 0.076 0.085 -0.137 0.53 0.0618 0.0896 2.7724 14.1578Tobin’s Q 0.923 1.016 0.059 7.113 0.6589 0.9891 4.4896 25.8754 altz 3.824 5.928 0.116 33.113 1.9089 3.6978 3.4560 15.5165*bs was returned to exponential form, i.e. absolute valuesSource: STATA output Table 4: Descriptive statistics Table 4 shows number of observations, mean, median, standard deviation, maximum,and minimum as well the skewness which will give us an idea of how the distribution behave.The mean shows the average figure of the variable for the data set. The standard deviation(sd) is an indication of how the data deviates around the mean. It is a measure of dispersion 22
- 31. (variability). The higher the figure, the higher it deviates/scatters around the mean value andis an indication of margin of errors. The skewness measures the degree and direction ofasymmetry, whether the mean is less or greater than the median is the indication. If mean isless than the median, then the distribution is said to be negatively skewed and in the otherhand, if mean is greater than median, the distribution is said to be positively skewed. Anormal distribution has a skweness of 0. Kurtosis indicates how peak or pointed thedistribution is. Bell curve (mesocurtic , are considered to be perfect and has a kurtosis of 3 ).Heavy tailed distribution, with many outliers, will have a kurtosis greater than 3 (Flat -platykurtic). Light tailed distributions, less outliers will have kurtosis less than 3 (Sharp –leptokurtic). The figure 3 serves as a benchmark. We would focus more on the governance variables and from reference to the tableabove, board directors on average own only 9% which is significantly good and in line withagency theory, as principals have minority interest aligning maximising shareholders’ wealth.However, this figure does not reflect the whole sample. Some directors do not even haveinterest in company, or are relatively low. Whilst, some were originally private companiesbefore listing, obviously have board members holding significant interest in the company. Forexample directors of Gamma Civic Ltd owned more than 50% of the outstanding shares. Thesd is 0.14 meaning that values varies 14% around the mean and margin of errors is low. Asit can be seen in the percentile range, the median (24.4%) is greater than the mean (9%), thedistribution is concentrated to the right and the kurtosis of 9.5 shows that the distribution isheavily tailed and thus assumes a flat distribution. Ownership concentration is very high. The mean is 61%, i.e. top 10 shareholdersholds on average 61% of the company’s outstanding shares. Margin of error is also low. Insome companies, concentration is even 90%. 50% of companies in the sample haveownership concentration of 69.79 or more. The skewness is significantly positive andtherefore the data is significantly concentrated to the right and is heavily tailed. Board sizeaverages to 10 members. Lipton and Lorsch (1992) suggest an optimal board size between sevenand nine directors 75% of companies have 12 or more directors in the board. The distributionis however close to normal (skewness of -0.3 and kurtosis < 3). Board independence also isan important variable. The figures show that board are majorly consisted of non-executives(and/ or independent directors). 75% of companies consist of mainly non-executive s (and/orindependent directors). This is in line with the RCCG which specifies at least two twoindependent and two executive directors in the board. Audit committees have high 23
- 32. independency level. This is a major requirement of the Corporate Governance Code ofMauritius. Companies are therefore tending to adopt the code practices. This is the same forCEO duality where every company separated the powers of the CEO and the Chairperson andare occupied by two different persons. Again, this is in line with the code and whilecollecting data, I can further conclude that most of all CEO are non-executives. The CSRvariable cannot be described since (i) it is in exponential form and (ii) we are more concernedon its impact than CSR itself since some contributes massively and even have foundationswhile some contribute a relatively low amount either they are subsidiaries of the foundationor otherwise. Firms on average have a debt ratio of 24% which is relatively low. Firms are lowgeared. Variability is also low; low sd, 75% have debt/equity of at least 34.25%, skewness ispositive and low and also kurtosis is 4.12. However, some firms are highly geared (92% asmaximum). Return on asset averages to 7.6%. sd is less than 10%. While some companiesreported negative return. Tobin’s Q mean is 92.3% which means 92.3% of total assetscontribute to the total market value of firm. This means that total assets are wisely employed.Again, the distribution is heavily tailed to the right. Altman Z-score on average is 3.824 (> 3 indicating high bankruptcy). This data aloneis not reliable since the sd is 598.28%! This is due to the presence of the inclusion of differentindustries in the same sample. Every company need not to have same ratios which areweighted in the formula. Some companies, especially those in banking sector had negativeworking capital/ total assets ratio since liabilities are greater than assets. Deposits fromcustomers are liabilities! The distribution is heavily tailed to the right and is thereforeaffected by outliers. 24
- 33. 4.2 Corporate Governance and capital structure A very laborious literature is found on the debate about the link between capitalstructure and corporate governance which is at heart of agency theory. All the corporatevariables and controlling variables were analysed on dependent variable, which is debt tototal of debt and market equity. The following are the variables used in this section:Dependent variable (Y): levmvIndependent variables (X): os, oc, bs , bi, aci, ceod, csr, sg, roe, size4.2.1 Correlation The Person correlation was performed to measure the degree of linear relationshipbetween the variables. It shows how close two variables are assuming that it is linear and is ameasure of how tightly cluster data are about the correlation line. Ranging from -1 to +1,negative coefficient indicates a negative relationship. The table below present the correlationscoefficients and its significance in parentheses. 25
- 34. levmv os oc bs bi aci ceod csr sg roe size os -0.041 1 (0.683) oc -0.137 -0.044 1 (0.175) (0.667) bs 0.156 -0.475* 0.146 1 (0.121) (0) (0.148) bi 0.168** -0.267** 0.075 0.338* 1 (0.096) (0.007) (0.456) (0.001)aci -0.138 -0.018 0.068 0.107 0.348* 1 (0.171) (0.856) (0.503) (0.291) (0)ceod -0.089 -0.446* 0.028 0.1762** 0.023 0.044 1 (0.377) (0) (0.784) (0.08) (0.818) (0.665)csr -0.061 -0.075 0.157 0.4164* 0.046 0.009 -0.059 1 (0.55) (0.462) (0.118) (0) (0.653) (0.931) (0.559) sg 0.126 0.041 0.128 -0.159 -0.230** -0.073 -0.021 0.057 1 (0.211) (0.685) (0.204) (0.115) (0.022) (0.47) (0.832) (0.573)roe -0.025 -0.035 0.4109* 0.137 0.036 0.104 0.037 0.141 0.022 1 (0.807) (0.732) (0) (0.173) (0.719) (0.305) (0.717) (0.161) (0.827)size 0.276* -0.180** -0.358* 0.235** 0.001 -0.016 0.048 0.438* -0.015 -0.191** 1 (0.006) (0.073) (0) (0.019) (0.995) (0.875) (0.638) (0) (0.884) (0.057) Table 5: Correlation capital structure and corporate governance 26
- 35. From table 5, using the Pearson correlation, levmv is positively correlated to boardindependence and is significant at the 0.01significance level and firm size also is positive andsignificant at the 0.05 level. Board shareholding, ownership concentration, and auditcommittee are negatively correlated. This means that, for instance, when board shareholdingincreases, decisions about debt tend to be less favourable and prefer equity finance. This is arational behaviour as they fear any risk of bankruptcy being heavily debt. They tend to avoiddebt finance. This is consistent with Jensen (1986), Berger et al. (1997) and Abor (1997). Board size is positively correlated to leverage. Thus This is consistent with Wen etal.(2002) and Abor (2007). Berger et al. (1997) on the other hand, found that large board sizeresults in low leverage levels. Furthermore, CEOs also seem to avoid leverage but the valueis not significant. A thorough study of the relationship between dependent variables reveals that they arenot, at most perfectly correlated. Correlation coefficients ranges from –0.5 to +0.5 .Testingfor correlation is important as this may lead to high coefficient standard errors and low t-statistics making it harder to reject the null hypothesis. However, as we shall consider in thenext section while doing the OLS estimation (after being tested), multicollinearity presencedid not violate the estimations. OLS estimates are still unbiased and BLUE (Best LinearUnbiased Estimators)4.2.2 Regression results and discussion Before beginning with analysis of the study, we have first to ascertain whichestimation model is appropriate and fits the data the best. The model with best with better 2goodness-of-fit measures (like R ,test for heterosdasticity and test for autocorrelation),parameter estimates with their standard errors, and test results will be selected. This will thenbe coupled with Hausman test for fixed versus random effects, F-tests to test for any fixedeffects, Breusch and Pagan Lagrangian Multiplier test for any random effects. 27
- 36. Now we start our analysis. I first use Hausman test. The Prob>chi2 = 0.1296, andthus the test provides decisive evidence that the H0 is wrong at the 0.05 level. We thereforereject the null hypothesis at the 0.1 level and thus the random model is preferred. Inconnection, we run the BPLM test for random effects. The chibar2(01) = 46.10 andProb > chibar2 = 0.0000, we reject Ho at the 0.05 level and thus the random effects is againfavoured against the OLS. However, we also run the F-test to validate the non-presence offixed effects. The xtreg command renders Prob > F = 0.0000 which is less than the 0.05. Wetherefore reject the null hypothesis at the 0.05 level as there is sufficient evidence; significantincrease in goodness of fit in the fixed effect. We can still not conclude on which estimationsuits the data best. We shall now compute the three estimation models and observed thegoodness of fit. The table below summarises estimation results from OLS, fixed effects (LSDV) andrandom effects (re theta and GLS). It appears that the random effect model does not suit theestimation. The goodness of fit values is insignificant and also no significant coefficients areproduced. The fixed effect model renders R2 of 77.16% but produces no sufficientinformation about the link between the variables. The OLS seems appropriate. Table 6 showsthe statistics when different estimation model applied. Variable OLS Fixed effects Random effects os 0.23455 0.14386 0.04819 (0.1381) (0.1955) (0.1536) [1.699] [0.7358] [0.3138] oc -0.00093 0.00019 0.00078 (0.00111) (0.00224) (0.00086) [-0.8424] [0.08605] [0.9049] bs 0.3355 0.26105 0.27873 (0.1746) (0.1558) (0.308) [1.922] [1.676] [0.9051] bi .57292** 0.30406 0.21723 (0.1763) (0.1966) (0.1317) [3.249] [1.547] [1.649] aci -0.49383 -.37182* -0.30666 (0.2559) (0.1612) (0.2329) [-1.93] [-2.306] [-1.316] ceod -.14908* -0.13009 -0.11539 28
- 37. (0.06941) (0.1044) (0.07418) [-2.148] [-1.246] [-1.555] csr -.0483*** -.02466* -0.01933 (0.01416) (0.0119) (0.01287) [-3.411] [-2.072] [-1.502] sg .20684** 0.09055 0.06775 (0.06155) (0.06678) (0.04732) [3.361] [1.356] [1.432] Roe .10648* 0.03331 0.00821 (0.04614) (0.07959) (0.06782) [2.308] [0.4185] [0.1211] Size .05518*** 0.03168 0.00621 (0.01287) (0.01643) (0.01217) [4.286] [1.928] [0.5097] _cons -.976* -0.52045 -0.31626 (0.4408) (0.5048) (0.8541) [-2.214] [-1.031] [-0.3703] F-test 2.98 6.46 13.02 (model) p-value 0.0028* 0* 0.2226 DF 99 94 94 2 R 0.2506 0.7716 0.3268 SSE 4.11087 1.25266661 0.13882289 (SRMSE) Root /mse 0.21492 0.13882 σu 0.170409 θ 0.6577 Effect test 6.18* 5.74 N 100 100 100Coefficient/ standard error/t-statistic* p<0.05; ** p<0.01; *** p<0.001Significant coefficients in boldSTATA OutputTable 6: Regression results, capital structure and corporate governance 29
- 38. [ R2 = 0.2936; Adj R2=0.1664, SSE= 4.11, F=2.98* , mse= 0.21492]Regression equation: levmv= 0.235 OS – 0.001 OC+0.336 BS+0.573 BI-0.494 ACI-0.149 CEOD-0.048 CSR+0.207 SG+0.107 ROE+0.55 SIZE- 0.976Special Wald Test: F( 10, 89) = 3.70, Prob > F = 0.0004 Unstandardised coefficients standardised Collinearity statistics coefficients levmv Coef. Robust Std. Beta t P>t [95% Conf. VIF tolerance Err. Interval] os 0.2345 0.1381 0.1441 1.7 0.093 -0.1403 0.6094 1.69 0.5911 oc -0.0009 0.0011 -0.033 -0.84 0.402 -0.0072 0.0053 1.54 0.6511 bs 0.3355 0.1746 0.2663 1.92 0.058 0.0381 0.6329 1.78 0.5623 bi 0.5729** 0.1763 0.2697 3.25 0.002 0.1300 1.0159 1.39 0.7206 aci -0.4938 0.2559 -0.2342 -1.93 0.057 -0.8970 -0.0907 1.17 0.8571 ceod -0.1491* 0.0694 -0.1086 -2.15 0.034 -0.4252 0.1271 1.29 0.7748 csr -0.0483*** 0.0142 -0.3844 -3.41 0.001 -0.0774 -0.0192 1.71 0.5858 sg 0.2068** 0.0615 0.235 3.36 0.001 0.0423 0.3714 1.12 0.8966 roe 0.1065* 0.0461 0.105 2.31 0.023 -0.0940 0.3069 1.25 0.8018 size 0.0552*** 0.0129 0.4204 4.29 0 0.0247 0.0856 1.72 0.5831 _cons -0.9760* 0.4408 . -2.21 0.029 -1.8797 -0.0723 Mean VIF=1.46* p<0.05; ** p<0.01; *** p<0.001 level of significance Table 7 Multiple regression result: leverage and corporate governance 30
- 39. IM test for Ho: homoscedasticity; Chi(2)=87.20, p=0.0534, Likelihood-ratio test : sig= 0.03 Durbin-Watson d-statistic( 11, 100) = 1.359768 9 The Special Wald test was first performed as to test whether at least one of thegovernance variables is significant at the 0.05 level. The p-value is 0.0004 which is lowerthan the 5% level of alpha. Hence, we can reject the null and at least some independentvariables are significant. This reinforced significant values if only looking at the F-test. Thehigh p-value of the IM test for heteroskedasticity shows that heteroskedasticity was aproblem at the 5% level and the robustness function was used to capture any presence sincethe no-one knows the true value of p. A test for autocorrelation was also performed,represented by the Durbin-Watson test. The d-statistic is 1.36, and stands in the zone ofindecision for possible autocorrelation. As a rule of thumb, if a VIF is in excess of 9 or atolerance (1/VIF) is .05 or less, there might be a problem of multicollinearity (Lazaridis andTryfonidis, 2006). We therefore assume that the OLS assumptions are not violated. Thelikelihood–ratio test is significant at the 0.05 level, thus there is an evidence of associationbetween leverage and the corporate variables. From the table 8, the R-square is 29.36%. This means that 29.36% of the variance inleverage is explained by the independent governance variables. The higher the figure, thebetter the variance is explained. The model being significant but R 2 small, it implies thatobserved values are widely scatter around the regression line. The F-statistic of the OLSestimation is 2.98 and therefore significant at the 0.05 level. This means that the modelstatistically reliable and is not spurious. The RMSE is the square root of the variance of theresiduals. RMSE is an absolute measure of fit. From Table 7, 21.5% of the observed datapoints are close to the model’s predicted value. The beta value of is a measure of howstrongly each independent variable influences leverage. The beta is measured in units ofstandard deviation. For example, a beta value of 0.1441 for ownership structure indicates thata change of one standard deviation in the leverage will result in a change of 0.1441 standarddeviations in the ownership structure variable. Thus, the higher the beta value the greater theimpact of the independent variables on leverage. Having analysed goodness of fit, we arenow going to test our previous hypotheses introduced in chapter 1.9 From Durbin Watson significance table, dU=1.314, dL=1.79 31
- 40. H1: There is a significant relationship between ownership structure and firms capitalstructureBoard ownership is positively related to leverage. The standard deviation is 0.1381, i.e.observed values differ by 13.8% around the mean value. However, no significant relationshipwas found. Agrawal and Mandelker(1987) also found a positive relationship.H2: There is a significant relationship between ownership concentration and firms capitalstructureOwnership concentration is negatively related to leverage. No significant relationship wasfound.H3: There is a significant relationship between board size and firms capital structureEven board size is positively related to leverage. Despite not being significant, this result isconsistent with Wen et al.(2002) and Abor(2007). Also big boards have larger debt in theircapital as argued by Jensen (1986). Larger board size translates into strong pressure from thecorporate board to make managers pursue lower leverage or debt ratio rather than have largerboards.H4: There is a significant relationship between board independence and firms capitalstructure.There is a positive and significant relationship (at the 0.01 level) between boardindependence and leverage. This means that executive board members prefer low leverageand therefore use internal finance first. Since they have interest on the company, they will notwant to take huge risks in leverages. This is refuting Wen et al. (2002) where a significantnegative relationship was found but is consistent with Berger et al. (1997). The coefficient0.573 means that for every one % increase in board independence, i.e. a non-executivejoining in, leverage is expected to increase by 0.573 %, assuming ceteris paribus. 32
- 41. H5: There is a significant relationship between independent audit committee and firmscapital structureA negative relationship exists between audit and leverage. Besides, it is not significant.H6: There is a significant relationship between CEO duality and firms capital structureCEO duality has a negative and significant relationship at the 0.05 level. This means that solong as CEO and Chairman Position are occupied by the different persons, leverage willdecrease. This might reveal that CEO and Chairman decisions on leverages do not tally.H7: There is a significant relationship between social responsibility and firms capitalstructureAs the companies contribute more towards social responsibility, leverages tend to decrease.The study shows a negative relationship and this is statistically significant at the 0.001significance level. This might possibly means that as company contributes more to CSR,sales revenue increases and building internal finance in the form of retained earnings. This isfurther backed by a positive relationship between sales growth and leverage. This mightexplain the pecking order theory.The study also reveals that profitability (roe) is also significantly related to leverage (at the0.05 level) and this is consistent with pecking order hypothesis. For every one % increase inprofitability, leverage is expected to increase by 0.106%. In addition, the study reports thatother determinants that do not proxy for control rights are consistent with previous findings.Firms that are larger have more tangible assets and are also more leveraged. In this vein, the submission of this study is that the issue of capital structure is more ofan empirical issue than theoretical proposition since it is different from countries to countries,perhaps depending on the level of development. However, the limitation of this study is thatwe cannot conclude if this assertion also holds across different sectors in the same country oreconomy. 33
- 42. 4.3 Corporate Governance and Firm Performance4.3.1 Correlation ROA Q AltZ os 0.008 -0.025 -0.002 (0.938) (0.803) (0.987) oc 0.5796* 0.4551* 0.5589* (0.000) (0.000) (0.000) bs 0.098 0.2295* 0.130 (0.334) (0.022) (0.208) bi -0.034 0.138 0.120 (0.735) (0.170) (0.244) aci 0.166 0.054 0.121 (0.099) (0.597) (0.240) ceod 0.027 0.089 0.058 (0.787) (0.377) (0.573) csr -0.028 0.054 -0.024 (0.786) (0.591) (0.817) sg -0.086 -0.020 -0.039 (0.394) (0.845) (0.710) roe 0.4617* 0.3874* (0.000) (0.000) size -0.470* -0.4523* -0.6171* (0.000) (0.000) (0.000) Correlation coefficient and significance value given in ( ). * p<0.05; level of significance Table 8 Correlation: Corporate governance and performanceIn the table, variables which are statistically significant at respective significance level areshown in bold. Board ownership, large block shareholders, board size, corporate socialresponsibility and sales growth are negatively correlated. Only board independence, ceod,return on equity and size is positively related. Inclusion of outside directors in the boardlowers return on asset but however is positively related to npm, Tobin’s Q and altman ZScore. This is consistent with Brown and Caylor (2006) who found that firms with more 34
- 43. independent directors performed well while Agrawal and Knoeber (1996) found an oppositeview. As from the table, it is more likely to be positive related, to three dependent variables.CEO duality is positively correlated to all performance proxies. This is consistent Sanda et al.(2003) who found a positive relationship between separate CEO and Chairman positions andfirm performance. CSR seems to be relatively uncorrelated. Size is negatively related to mostproxies. As expected, an increase in assets does not necessarily increase performance.Increase in size may be attributed to other reasons like manufacturing process. However, it isstatistically significant at the 0.01 level.4.3.2 Regression results and discussion The Fixed effect model (Least Square Dummy Variable) was used for return on assetwhile Tobin’s Q and Altman Z-score used OLS multiple regression model coupled withappropriate tests. Regression results can be found in Appendix E.ROA as dependent roa Coef. Std. Err. t P>t os 0.024 0.096 0.25 0.801 oc 0.002* 0.001 2.55 0.013 bs 0.118 0.077 1.53 0.13 bi -0.115 0.078 -1.47 0.147 aci 0.001 0.060 0.02 0.987 ceod -0.020 0.039 -0.51 0.611 csr -0.005 0.005 -1.09 0.279 sg -0.018 0.025 -0.73 0.468 size 0.018* 0.008 2.25 0.028 _cons -0.224 0.262 -0.85 0.396 F test (model) 5.53, p-value 0.0000, Obs.=100, R2 =0.7337, SSE 0.1913 Breusch-Pagan / Cook-Weisberg test for heteroskedasticity: chi2(1) = 68.27,Prob > chi2 = 0.0000 Durbin-Watson d-statistic( 10, 100) = 1.79 * p<0.05; ** p<0.01; *** p<0.001 level of significance Table 9 Regression results: ROA and governance (Fixed Effect model) 35
- 44. BP test shows that variance are constant, i.e heteroskedasticity was not a problem (p-value< 0.05 at the 5%level). The d statistics is 1.7910 and therefore in in the vicinity of 2,indicating that autocorrelation was not at least present. This reinforces the p-value of thefixed effect model and therefore will produce unbiased estimates. The core assumptions ofthe panel data model were not violated. The fixed effect model for return on asset shows a negative relationship betweenboard equity, board independence, CEO duality CSR and sales growth. Ownershipconcentration, board size, audit and size have positive relationship. The p-value for the modelis 0.0000 which therefore reveals that the model fits the observed data at the 0.05 level. R 2 ishigh at 0.7337. 73.37% variation in roa is explained by independent variables. This low p-value and high R2 means that the observed value are closely scattered around the regressionline. The sum of squares, i.e. residuals is very low. This further explained the goodness fit ofthe model. The F-test for fixed effect test is 2.50 (p-value 0.0018) and therefore we reject thenull hypothesis that means of dummy variables are zero as the 0.05 level and hence use fixedeffects as there are significant statistical evidence. The regression output revealed thatownership concentration is positively and statistically significant (at the 0.001) level with roa.As more large shareholders invest massively, the firm successfully grow and profitabilityincreases. Large shareholders are often institutions and other companies. This adds morepressure to the board to perform well.10 d < 2 for positive autocorrelation of the residuals, d >2 for negative autocorrelation and d~2 for zerocorrelation 36
- 45. Tobin’s Q as dependent variable Unstandardised standardised Collinearity coefficients coefficients statistics Q Coef. Robust Beta t P>t VIF tolerance Std. Err. os 0.692* 0.304 0.098 2.27 0.025 0.025 0.591 oc 0.016 0.035 0.133 0.47 0.642 0.642 0.651 bs 1.328* 0.659 0.244 2.02 0.047 0.047 0.562 bi 0.643 0.465 0.07 1.38 0.17 0.17 0.721 aci -0.416 0.482 -0.046 -0.86 0.39 0.39 0.857 ceod 0.611** 0.222 0.103 2.75 0.007 0.007 0.775 csr 0.052 0.031 0.096 1.68 0.096 0.096 0.586 sg -0.02 0.177 -0.005 -0.11 0.91 0.91 0.897 roe 1.217 1.123 0.278 1.08 0.281 0.281 0.802 size -0.249* 0.110 -0.439 -2.27 0.026 0.026 0.583 _cons 1.688 1.911 . 0.88 0.38 0.38F test (model)=7.67, p-value= 0.0000, Obs.=100, R2= 0.4628, Adj R2= 0.4024, SSE= 54.866Mean, VIF=1.46Whites test: chi2=111.58 p-value= 0.0007Likelihood-ratio test : LR chi2(1) = 7.91, Prob > chi2 = 0.0049Durbin-Watson d-statistic( 11, 100) = 1.586145 Table 10 Regression result for Tobins Q and governance ( OLS) OLS was deemed to be appropriate for Tobin’s Q dependent variable. Goodness of fitmeasures is significmant. The likelihood ratio test shows the evidence of linear associationbetween Q and governance variables. Ownership structure is positively and significantlyrelated to firm’s value. Jensen and Meckling (1976) showed that when managerial ownershipfalls, the agency costs increase, since anagers can benefit from the consumption of non-pecuniary benefits. Managers here are however motivated by incentives as they will benefitfrom a larger proportion of the benefits associated with their effort. This ultimately increasesfirm value. Director’s remuneration and share schemes should be considered. Also, the study 37

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