Showing papers on "Agency cost published in 2010"

Capital structure, equity ownership and firm performance

Abstract: This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.

Board ownership, audit committees' effectiveness and corporate voluntary disclosures

Abstract: – The aim of this paper is to examine the linkages between board ownership, audit committees' effectiveness in terms of the proportion of independent non‐executive directors (INED) and expert members on the audit committee and corporate voluntary disclosures., – The paper is based on a sample of 124 public listed companies in Malaysia for studying differences in corporate governance characteristics which affect the financial disclosure., – The empirical results indicate that that board ownership is associated with lower levels of voluntary disclosures. The result is consistent with the notion that board ownership increases agency costs resulting from information asymmetry between firm management and outsider investors. The negative relationship between board ownership and corporate voluntary disclosure is, however, weaker for firms with higher proportion of INED on the audit committee indicating that INED moderate board ownership/corporate voluntary disclosure relationship. Overall, the findings lend support for firms with a higher level of board ownership to include more independent directors on the audit committee to increase disclosure levels and reduce information asymmetry between firm management and investors., – This paper demonstrates the usefulness of corporate governance factors mainly board ownership and effective audit committee on financial reporting practices. It is expected that this research will have important policy implication to reduce information asymmetry and improves corporate governance.

Agency costs, ownership structure and corporate governance compliance: A private contracting perspective

Abstract: This paper examines whether the adoption of specific corporate governance practices, and, in particular, adherence to an overall code of governance practice, is associated with agency cost benefits for companies listed on the Australian Securities Exchange (ASX). Using a private and voluntary contracting setting, the adoption of individual corporate governance attributes is found to have no influence on firm-level agency costs, whereas greater compliance with an overall governance index variable representative of the ASX Corporate Governance Council requirements now in force results in significantly lower agency costs. The beneficial influence of voluntary governance compliance on agency costs is also found to be independent of firm ownership structure, with these findings having a range of implications for firms both in Australia and globally.

Evidence on the Role of Accounting Conservatism in Monitoring Managers' Investment Decisions

Abstract: Watts (2003), among others, argues that conservatism helps in corporate governance by mitigating agency problems associated with managers’ investment decisions. We hypothesize that if conservatism reduces managers’ ex ante incentives to take on negative NPV projects and improves the ex post monitoring of investments, firms with more conservative accounting ought to have higher future profitability and lower likelihood (and magnitude) of future special items charges. Consistent with this expectation, we find that firms with more conservative accounting have (i) higher future cash flows and gross margins, and (ii) lower likelihood and magnitude of special items charges than firms with less conservative accounting.

Agency Cost, Top Executives’ Overconfidence, and Investment-Cash Flow Sensitivity - Evidence from Listed Companies in China

Abstract: We examine the effect of agency cost on the relation between top executives' overconfidence and investment-cash flow sensitivity using the data from Chinese listed companies. We find that on average top executives' overconfidence leads to increased investment-cash flow sensitivity. However, this relation holds only for companies with state-owned entities as controlling shareholders. In contrast, the relation is not significant for non-state controlled firms. We construct proxy for agency cost and find that state-controlled companies have significantly greater agency cost than non-state controlled companies. Results on sub-samples sorted by agency cost again show that the positive effect of top executives' overconfidence on investment-cash flow sensitivity holds only for companies that exhibit high agency cost. Our results therefore suggest that agency cost has a significant impact on the relation between top executives' overconfidence and investment-cash flow sensitivity, and the investment distortion due to top executives' overconfidence behavior may be alleviated by reducing agency cost through elevated supervision.

Culture, Agency Costs, and Dividends

Abstract: This paper presents a culturally rooted agency explanation for differences in dividend payout policies around the world. We conjecture that the social normative nature of culture influences the character of agency relations and determines the acceptance and legitimacy of different dividend payout strategies across different countries. By linking dividends to cultural differences across 5,797 firms in 41 countries, our analysis shows that high individualism, low power distance, and low uncertainty avoidance are significantly associated with higher dividend payouts. A comprehensive set of robustness tests in which we control for legal institutions, share repurchases, corporate debt ratios, and ownership structures confirms that culture is a relevant factor when analyzing dividend distributions. Our results further show that legal institutions and culture as a social institution have complementary effects on dividend payouts. Overall, our finding that culture matters suggests important implications for a wide range of agency-based economic and capital market phenomena.

Optimal Monetary Policy in a Model with Agency Costs

Abstract: This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output-gap version of the Phillips curve. The model's utility-based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking.

Family control and the implied cost of equity: Evidence before and after the Asian financial crisis

Abstract: Recent research emphasizes that corporate governance becomes critical during economic crises, when the incentives for expropriation of minority shareholders increase. Using the high-profile Asian financial crisis of 1997–1998 and a sample of 566 firms from eight East Asian countries over 1996–1999, we examine the link between family control and agency costs evident in the cost of equity financing for firms. We find that, before the crisis, family control is unrelated to firms' equity financing costs, whereas, following the crisis, family control is related to a higher cost of equity. This suggests that the crisis made investors aware of the potential entrenchment of controlling families, prompting them to require a higher-equity premium from family firms. Our results are robust to various models of the cost of equity capital, additional firm- and country-level governance traits, and additional alternative explanations, including the presence of other types of large shareholders and potential survivorship bias. Our study contributes to our understanding of the corporate governance of family-controlled firms, especially during economic crises.

Fair Value or Cost Model? Drivers of Choice for IAS 40 in the Real Estate Industry

Abstract: The IFRS mandatory adoption in European countries is an excellent context from which to assess the validity of accounting choice theory, which postulates that information asymmetry, contractual efficiency (agency costs) and managerial opportunism reasons could drive the choice. With this aim, we test the impact of these factors to explain the adoption of fair value for investment properties (IAS 40) in the real estate industry, taking into account the ‘revaluation’ option offered by IFRS1 and using historical cost without revaluations as a baseline category for comparison purposes. We select a sample of European real estate companies from Finland, France, Germany, Greece, Italy, Spain and Sweden, all first-time adopters of the IFRS. Using a multinomial logistic model, we show that information asymmetry, contractual efficiency and managerial opportunism could account for the fair value choice. Particularly, the most significant findings are that size as a proxy of political costs reduces the likelihood of ...

Determinants of Director Compensation in Two-Tier Systems: Evidence from German Panel Data

Abstract: Building on a unique panel data set of German Prime Standard companies for the period 2005-2008, this paper investigates the influencing factors of both director compensation levels and structure, i.e. the probability of performance-based compensation. Drawing on agency theory arguments and previous literature, we analyze a comprehensive group of determinants, including detailed corporate performance, ownership and board characteristics. While controlling for unobserved heterogeneity, we find director compensation to be set in ways consistent with optimal contracting theory. i.e., compensation is systematically structured to mitigate agency conflicts and to encourage effective monitoring. Thus, our results indicate that similar types of agency conflicts exist in the German two-tier setting.

Outside directors on Korean Boards: governance and institutions

Abstract: Drawing on institutional theory, this study examines the factors that pressured Korean firms to appoint outside directors to their boards. While this practice could be considered to be a management innovation in Korea, in the Anglo-American corporate governance system it has long been used as one of several mechanisms to mitigate agency costs between management and shareholders. As such, this response by Korean firms, following the 1997–98 currency crisis in Asia, could be seen as an example of corporate governance convergence on the Anglo-American model, where higher levels of outside director representation on the board are the norm. We examine the antecedents of having a higher proportion of outside directors on Korean boards. Our findings indicate that larger firms that are under stricter control by the government have higher representation of outside directors on the board. We also find a positive and significant relationship between the proportion of outside directors and business group affiliation, poor prior firm performance, higher levels of debt and foreign ownership.

Concentrating on Governance

Abstract: This paper develops a novel trade-off view of corporate governance. Using a simple model that integrates agency costs and bargaining benefits of management-friendly provisions, we identify the economic determinants of the resulting trade-offs for shareholder value. Consistent with the theory, our empirical analysis shows that provisions that allow managers to delay takeovers have a significant bargaining effect and a positive relation with shareholder value in concentrated industries. By contrast, non-delay provisions have an unambiguously negative relation with value, and more so in concentrated industries. Overall, our analysis suggests that there are governance trade-offs for shareholders and industry concentration is an important determinant of their severity.

Risk Shifting Through Nonfinancial Contracts. Effects on Loan Spreads and Capital Structure of Project Finance Deals

Abstract: We study capital structure negotiation and cost of debt financing between sponsors and lenders using a sample of more than 1,000 project finance loans worth around US$195 billion closed between 1998 and 2003. We find that lenders: (i) rely on the network of nonfinancial contracts as a mechanism to control agency costs and project risks, (ii) are reluctant to price credit more cheaply if sponsors are involved as project counterparties in the relevant contracts, and finally (iii) do not appreciate sponsor involvement as a contractual counterparty of the special purpose vehicle when determining the level of leverage.

Culture, Agency Costs and Dividends

Abstract: This paper presents a culturally rooted agency explanation for differences in dividend payout policies around the world. We conjecture that the social normative nature of culture influences the character of agency relations and determines the acceptance and legitimacy of different dividend payout strategies across different countries. By linking dividends to cultural differences across 5797 firms in 41 countries, our analysis shows that high individualism, low power distance, and low uncertainty avoidance are significantly associated with higher dividend payouts. A comprehensive set of robustness tests in which we control for legal institutions, share repurchases, corporate debt ratios, and ownership structures confirms that culture is a relevant factor when analyzing dividend distributions. Our results further show that legal institutions and culture as a social institution have complementary effects on dividend payouts. Overall, our finding that culture matters suggests important implications for a wide range of agency-based economic and capital market phenomena. Journal of Comparative Economics 38 (3) (2010) 321-339. Warwick Business School, University of Warwick, Coventry CV4 7AL, United Kingdom; Harvard University, Department of Government, Cambridge, MA 02138, United States; European Business School (EBS), Oestrich-Winkel, Germany. (C) 2010 Association for Comparative Economic Studies All rights reserved.

The Case against Shareholder Empowerment

Abstract: Many look toward enactment of the law reform agenda held out by proponents of shareholder empowerment as a part of the regulatory response to the financial crisis. This Article argues that the financial crisis exposes major weaknesses in the shareholder case. Our claim is that shareholder empowerment delivers management a simple and emphatic marching order: manage to maximize the market price of the stock. And that is exactly what the managers of a critical set of financial firms did in recent years. They managed to a market that focused on increasing observable earnings and, as it turned out, failed to factor in concomitant increases in risk that went largely unobserved. The fact that management bears primary responsibility for the disastrous results does not suffice to effect a policy connection between increased shareholder power and sound regulatory reform. A policy connection instead turns on a counterfactual question: Whether increased shareholder power would have imported more effective risk management in advance of the crisis. We conclude that no plausible grounds exist for making such a case. In the years preceding the financial crisis, shareholders validated the strategies of the very financial firms that pursued high leverage, high return, and high risk strategies and penalized those that did not. It is hard to see how shareholders, having played a role in fomenting the crisis, have a positive role to play in its resolution.The prevailing legal model of the corporation strikes a better balance between the powers of directors and shareholders than does the shareholder-centered alternative. Shareholder proponents see management agency costs as a constant in history and shareholder empowerment as the only tool available to reduce them. This Article counters this picture, making reference to agency theory and recent history to describe a dynamic process of agency cost reduction. It goes on to show that shareholder empowerment would occasion significant agency costs on its own by forcing management to a market price set in most cases under asymmetric information and set in some cases in speculative markets in which heterogeneous expectations obscure the price’s informational content.

Measuring Performance Through Capital Structure: Evidence from Banking Sector of Pakistan

Abstract: Capital structure of the financial institutions and banks determine agency cost of financial sector of the economy. In this study we explore the agency cost hypothesis of banking sector of Pakistan using panel data of 22 banks for the period 2002 to 2009. We employed the idea of using profit as a measure of efficiency of banks following Berger (2002) and the idea of using Tobin’s Q as a measure of firm’s performance following Morck, Shleifer, and Vishny (1988); Treece et al. (1994). Our study differs from the others in terms of methodology of panel data models which provide a better substitute for SUR and simultaneous equations employed by the other studies. Pooled data results prove agency cost hypothesis and the findings are in accordance with those of Pratomo and Ismail (2007) Berger and Di Patti (2002). Size of banks and consumer banking seem to have played significant role in their profit efficiency during the period from 2002 to 2009. Random effects and fixed effects models nevertheless, proved Miller-Modigliani (1958) proposition that capital structure does not affect value of the banks.

The Vote is Cast: The Effect of Corporate Governance on Shareholder Value

Abstract: This paper investigates whether improvements in the firm's internal corporate governance create value for shareholders. We analyze the market reaction to governance proposals that pass or fail by a small margin of votes in annual meetings. This provides a clean causal estimate that deals with the endogeneity of internal governance rules. We find that passing a proposal leads to significant positive abnormal returns. Adopting one governance proposal increases shareholder value by 2.8%. The market reaction is larger in firms with more antitakeover provisions, higher institutional ownership, stronger investor activism, and for proposals sponsored by institutions. In addition, we find that acquisitions and capital expenditures decline and long-term performance improves.

The Role of Auditing in Small, Private Family Firms: Is It About Quality and Credibility?

Abstract: The authors present empirical evidence of how family ownership and control affect the demand for audit quality measured by audit firm size in a sample of small private firms. The results indicate that family-held or -controlled firms are less likely to use Big 4 auditors than nonfamily firms and that an increase in family ownership decreases the likelihood of a Big 4 audit. The results imply that the less concentrated family ownership is, the more need there is for outside control mechanisms because of higher agency costs. The results imply that family influence increases firms’ incentives to employ Big 4 audit firms, thereby increasing the credibility of their financial statements vis-a-vis outside stakeholders.

Capital Structure – Does Ownership Structure Matter? Theory and Indian Evidence

Abstract: Purpose – Based on the agency theory, the purpose of this paper is to theoretically argue and empirically investigate how ownership structure impacts the capital structure of the listed mid-cap companies in India and whether the capital structure as exogenous variable has a role in determining ownership structure as well. Design/methodology/approach – Simultaneity between capital structure and ownership structure is checked through Hausman specification test on endogeneity. Fixed effect panel regression model is used to analyze five years of data (2005-2009) on the sample units, to find the relation between leverage and ownership structure after controlling for profitability, risk, tangibility, growth and size. Findings – Empirical results on Indian firms suggest that the ownership structure does impact capital structure but not the vice versa. Consistent with theoretical prediction empirical results reveal that the leverage is positively related to concentrated shareholding and has a negative relation with diffuseness of shareholding after controlling for profitability, risk, tangibility, growth and size. The findings are consistent with “managerial entrenchment hypothesis” and “pecking order theory” of capital structure. Practical implications – The findings of the paper will enable the practitioners and analysts to understand as to why, in the bank and financial institution-dominated debt financing system in India, leverage is closely associated with concentrated ownership pattern and why retained earning is a preferred vehicle of financing for the firms with diffused shareholding. Originality/value – The results of the study enrich the literature on capital structure, agency cost and corporate governance issues in several ways.

Corpaorate Governance Mechanisms and Firm Valuation in Malaysian Listed Firms: A Panel Data Analysis

Abstract: Corporate governance mechanisms emerge to tackle agency problems in ensuring that shareholders' funds are not expropriated or wasted on unprofitable activities, The issue arises as to whether these improvements have been effective in reducing agency costs, and therefore enhancing firm value. The objectives of this paper is to examine the effects of governance mechanisms of dividend, types of ownership structure, and board governance on firm value. This paper utilises a panel data analysis of 403 firms Iisted on the Bursa Malaysia over a four-year period from years 2002 to 2005. A hierarchical regression analysis is used to test the hypotheses and the data is analysed using the generalized least square (GLS) estimation technique. Overall, the results highlight the importance of moderating role played by board governance variables with types of ownership structure to inf1uence firm value. However, the benefits of better corporate governance through enhanced board governance are not the same across all firms since their incentives vary with respect to dividend and different types of ownership structure mechanisms.

Pecking Order Behavior in Emerging Markets

Abstract: This paper examines the validity of the pecking order hypothesis in 23 emerging market countries. Emerging market countries would appear to be an ideal setting for the pecking order hypothesis to hold because of the presence of strong asymmetric information issues and agency costs. We observe, however, little support for the pecking order hypothesis as the primary financing theory for all emerging market firms. Firms in these countries finance their deficit mainly with equity, the opposite of what would be expected under this hypothesis. However, we do find support for the pecking order for firms in emerging market countries that suffer the most from either asymmetric information issues and/or agency costs. Our findings are consistent with the idea that the environment the firm operates in influences the financial decisions the firm makes.

The conditional nature of the value of corporate governance.

Abstract: Agency theory suggests that governance matters more among firms with greater potential agency costs. Rational investors are unlikely to value safeguards against unlikely events. Yet, few studies of the relation between governance and firm value control for investor perceptions of the likelihood of agency conflicts. Shleifer and Vishny [Shleifer, A., Vishny, R.W., 1997. A survey of corporate governance. Journal of Finance 52, 737–783] identify investment-related agency conflicts as the more severe type of agency conflicts in the US. We measure the perceived likelihood of this type of agency conflict using free cash flow (Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review 76, 323–329). We find that firm value is an increasing function of improved governance quality among firms with high free cash flow. In contrast, governance benefits are lower or insignificant among firms with low free cash flow. We show that not controlling for this conditional relation between governance and firm value could lead to erroneous conclusions that governance and firm value are unrelated.

Does a Family‐controlled Firm Perform Better in Corporate Venturing?

Abstract: Manuscript Type: Empirical Research Question/Issue: Family control involves issues of agency costs and nepotism. This study investigated the impacts of family control on stock market reactions to corporate venturing announcements by public firms. Moreover, in this paper we examined whether the monitoring effect of institutional investors influenced the relationship between family control and stock market reactions. Research Findings/Insights: In terms of research findings/results, with different measures of family control, the evidence indicated that family control is significantly and negatively associated with the abnormal returns of corporate venturing announcements. Furthermore, we found that the divergence of cash flow and voting rights had a strong negative impact on abnormal returns. Finally, the empirical results suggested that institutional ownership had a significant positive moderating effect on the relationship of family control and stock market reactions. Theoretical/Academic Implications: Prior research focused on the influence of private family firms on venturing activities. This study contributes to the literature by highlighting the unique characteristics of family control in public firms. This research suggests that nepotism embedded in public family firms is likely to create agency costs resulting from deviations in cash flow and voting rights. This study further shows that institutional ownership plays an important role in reducing agency costs associated with public family firms. Practitioner/Policy Implications: Our findings suggest that family control is an important consideration for investors in evaluating the wealth impacts of corporate venturing. Therefore, a well-established governance system could be a crucial signal of the quality of corporate venturing for family businesses, particularly the outside governance mechanism.

A Comparison Between One-Tier and Two-Tier Board Structures in France: Comparison Between One-Tier and Two-Tier Board Structures

Abstract: French companies operate in a unique environment characterized by the strong involvement of block shareholders such as families and banks. Furthermore, the French legal system allows firms to choose between a one-tier or a two-tier board structure. This study investigates whether this choice can affect the firm's operating and stock performance. Our regression results provide strong evidence that ownership and board structures are used together as corporate governance tools. In particular, the agency cost of debt is strongly affected by their interaction when institutional investors are also bank lenders. Our test results show that while family control has a negative impact on corporate governance, French institutional blockholders play a positive role as monitors of one-tier structures. In contrast, they are more likely to misuse the two-tier board system by promoting interlocked directorship, board opacity and their own interests as creditors. Our regression analysis reveals that foreign institutional investors do not have any impact on firm performance, regardless of board structure. Finally, we do not find any inverse relationship between board size and efficiency in France.