Impact of corporate governance on capital structure: mediating role of cost of capital

Abstract

PurposeThis paper contributes to the existing literature by extending the empirical work on the relationship between corporate governance and capital structure by analyzing the mediating role of cost of capital in the non-financial firms listed on the Pakistan Stock Exchange (PSX).Design/methodology/approachThe sample for this study includes non-financial firms listed on the Pakistan Stock Exchange (formerly Karachi Stock Exchange) for the period of 2004–2016. Based on 1800 firm-year observations, three approaches of panel data analysis are applied for the step-wise analysis of the underlying study. Firstly, Pooled OLS is applied. Secondly, fixed and random effect panel regression followed by the Hausman test to check the unobservable individual heterogeneity of the data. Hausman test indicates that the fixed-effects model is the most appropriate model for the sample panel data.FindingsThe study's findings are that board size, board composition, CEO/Chair duality, institutional ownership and managerial ownership have statistically significant direct effect on the firm's financing decisions. However, CEO/Chair duality, institutional ownership and managerial ownership have significant indirect effect on firm's capital structure decisions. The interesting finding of the paper is on the evidence of mediating role of cost of capital in the nexus of corporate governance and capital structure. Moreover, some conventional determinants of capital structure, including the firm's size, asset structure of the firm, profitability, business risk and growth, are found as determinants of capital structure decisions of the firms.Research limitations/implicationsThere are a few limitations to our study which could be addressed by upcoming research. We did not include all the four mechanisms of corporate governance including board structure, audit structure, compensation structure and ownership structure. However, we used only five important attributes including board size, board composition and CEO/Chair duality form board structure, managerial ownership and institutional ownership form ownership structure of corporate governance as our explanatory variables to examine their impact on the capital structure choices of the firms. Future studies may fill this research gap by involving some other attributes of corporate governance and analyzing their effectiveness and impact on value relevant capital structure decisions. Further, due to limited time and resources, we only tested the mediating role of cost of capital, hence, future researchers can analyze the mediating and moderating roles of different variables which may influence the relationship between corporate governance and capital structure choices of the firms.Practical implicationsThe study has many valuable guidelines and practical implications for the financial managers of the corporations. Our results will facilitate the policymakers in setting their corporate governance policies and practices and making the value relevant capital structure decisions in compliance with the implications of corporate governance mechanism. In addition, our study provides the empirical evidence in accordance with the argument that good governance practices, particularly the voluntary disclosures by the firm may reduce the information asymmetry which, ultimately, reduces the agency cost and the cost of capital for the firm. However, while deciding the financial policy of the corporations, managers can use our findings in order to assess the effectiveness of corporate governance practices employed by the firm in achieving the optimal capital structure at which the weighted average cost of capital is at its minimum level.Originality/valueThis paper contributes to the literature by investigating the mediating role of the cost of capital in the relationship between corporate governance and capital structure decisions of the firms. This paper provides empirical evidence that corporate governance indirectly affects capital structure decisions through the mediating role of cost of capital.

Conceptual Paper: Determinants of Capital Structure for Financially Distressed Firms Classified as Sharia-Compliant

“…First issue is on the disagreement on the determinants of capital structure. The findings of previous studies (see for example : Almaqtari et al, 2019;Ngatno et al, 2021) suggest that the choice of capital structure combination is consequence of many factors such as firm size (Hoque & Liu, 2021;Javaid et al, 2021), liquidity (Bukair, 2019;Bolarinwa & Adegboye, 2020;Zeitun & Goaied, 2021), profitability (Bolarinwa & Adegboye, 2020), interest rate (Kahya et al, 2020), EBITDA (Bolarinwa & Adegboye, 2020). The variables used by the previous researchers are selected based on their significance in specific theory, policy, or both.…”

“…Second issue is on the choice of population and sample used in the analysis. Previous studies have been conducted on a sample of firms from different sectors such as banking (Hoque & Liu, 2021;Kahya et al, 2020), hotel (Bolarinwa & Adegboye, 2020;Javaid et al, 2021;Zeitun & Goaied, 2021), oil and gas (Bolarinwa & Adegboye, 2020;Javaid et al, 2021) and trading and services (Bolarinwa & Adegboye, 2020). A major shortcoming of capital structure studies is that they generally restrict their analysis to conventional and healthy companies.…”

Technological Effectiveness, Clinical Credibility, Data Sources, and WBMS Behavioural Intention

“…The mediating impact was also investigated using the Sobel test. Because of the effects of a moderating effect [10], the Sobel analysis presumed that the correlations between the research variables had an indirect influence. The influence of the independent factors is decreased in a linear regression with the intermediary, but the impact of the intermediary is still technically meaningful.…”

Ineffective implementation of corporate governance? A call for greater transparency to reduce agency cost

“…As per Millar et al (2005), Gisbert and Navallas (2013), and Ashraf et al (2020), developing economies in Asia reveal business structures with inflated power centers, inadequate legal frameworks, weak dissemination of information, and practices that prioritize relationships over merit. Owing to the fact that boards are not independent and power centers continue to dominate in a firm setting, the execution of corporate governance codes is ineffective (Ameer, 2013;Butt et al, 2018;Javaid et al, 2021;Khalid et al, 2020;Nazir et al, 2013Nazir et al, , 2018. The level of information disclosure is relatively less in developing countries as compared to their developed counterparts (Tower et al, 2011;Uyar & Kılıç, 2012;Wang et al, 2008).…”