Research On The Relationship Between Corporate Governance, Capital Structure And Firm Performance In Developing Economies

The correlation between corporate governance, ownership structure and capital structure is one of the less understood areas within the finance Literature. Although previous studies have been done in these areas of research particularly in the advanced countries, very little is known about it in developing, emerging and transitional countries around the world. Thus, this study attempts to address this research gap within a unique organizational and institutional framework that may help explain the intricacies of such a relationship. The study therefore investigates the impact of corporate governance and ownership structure on corporate capital structure and its consequential effects on the performance of publicly listed firms in China. As the most rapidly developing economy in the world with distinctive characteristics, China provides a large and dynamic environment in which to investigate this subject.This study has its background on the agency theory and the data sample is based on 787 non-financial companies listed on the Shanghai and Shenzhen Stock Exchanges for the period 2001 to 2005. The study employed the panel data regression analysis to investigate possible link among the variables identified. The study found publicly listed firms in China to have serious agency problems ensuing from the separation of ownership and control, as a result of the recent economic reforms. Generally, poor corporate governance practice was found to create room for relatively high levels of leverage in capital structure and exacerbate the performance and value of the firms.In this study, perhaps the most interesting and striking findings are the influence of ownership structure such as state, Legal Person (institutional) and public holdings on capital structure and firm performance. State ownership was found to have a positive correlation with capital structure and negative association with firm performance. On the contrary, the Legal Person ownership was found to have a negative bearing on listed capital structure. Also, Legal Person holdings were found to influence firm performance positively. Public ownership was found to have influence on capital structure. Other issue identified in the empirical analysis is that ownership concentration was found to enhance optimal capital structure though the results are not significant. This variable was found too to also enhance listed firm performance and valuation. Ownership concentration was found to enhance optimal capital structure though the results are not significant. This variable was found to also enhance listed firm performance and valuation.Furthermore, the findings suggest that there is a correlation between the characteristics of a firm's board of directors and the capital structure and performance of firms. In particular, board size is found to have a negative association with leverage on the one hand, and on the other hand, a positive relationship with performance. The relationship between board size and performance explains that larger boards have a range of expertise among members and have better decision making ability. On the contrary, board skill and board composition (outside directors) are found to be positively correlated with performance and negatively associated with leverage, which explains the ability of outside directors with adequate skill to monitor and control managers in the use of debt while improving on performance. It is evident from this study that board structure can serve as a governance mechanism to reduce agency problem that is conspicuous among Chinese listed firms since the opening up reforms that began late 1970s.Another significant finding is the interaction between capital structure and firm performance. Capital structure is found to have positive and negative relationship with performance though this largely depends on the purpose and well utilization of leverage. On the other hand, firm performance was found to have a significantly and negatively correlation with corporate capital structure of publicly listed firms in China. Of the determinants of corporate capital structures, the findings indicate that leverage decreases with profitability, growth opportunities, and non-debt-tax-shield, but increases with firm size, assets structure and corporate income tax rate. Interestingly, the study showed listed firms in China to correspond mainly to short-term leverage nature on rollover basis. The pecking-order, trade-off and agency cost theories are found to be relevant in explaining the factors influencing capital structure decisions of publicly listed firms in China.The findings indicate that agency problem may be less severe if the state, at its various levels, can divest its holdings through a guided privatization program in which the state gives up a large proportion of its holdings to other investors especially the private shareholder.