2.

2 Corporate Governance and Capital Structure

Enormous amount of studies to analyze the impact of corporate governance on firms
capital structure have already been placed in many other developed countries. A widespread
review of literature shows that experiential work is mostly focused on the impact of good
governance on the organizations overall performance and also examines the influence of
ownership structure on value of the firm (Claessens, 2002). According to Graham, Harvey
(2001) and Litov (2005) Corporate governance is basically linked with the companys capital
structure and financing decision. Liao (2012) suggests that Good governance helps the
companies to manage their information more effectively due to which overall cost of capital
reduces and thus it helps the company to make effective and faster capital structure decisions.
However, in Pakistan this topic is newly discovered. There are mixed views found in
literature about the impact of corporate governance on capital structure. Some researchers found
that adopting corporate governance practices exert positive impact on capital structure and some
beliefs corporate governance negatively impact the firms performance and capital structure.
Claessens et al (2002) suggest that good corporate governance practices helps the organization to
have better access to financing and reduced overall cost of debt by winning the trust of investors.
Ownership Concentration or large amount of block holders suggests that there is
effective monitoring from investor on firms major decision that helps to reduce agency
conflicts. The block holders have more capability to influence management decision. They are
able to force management to take actions that are for the best interest of share holders and
maximize their overall wealth. According to Mehran (1992) there is a positive and substantial
relationship between ownership structure by largest investor and debt ratio. Though, this
relationship is not appropriate with long term debt ratio.
According to Jensen and Meckling (1976) Ownership structure helps to reduce agency
conflicts hence aligning the interest of share holder and manager. With high conflict of interest
between share holders and managers the corporate governance mechanism of organization is
generally weak. Fosberg (2004) argues that the no. of shares held by the block holders in an
organization is directly related to the total amount of debt in a firms capital structure but
inversely related to the total no. of block holders held by an organization
Board Size the larger the board size, the more effective will be the monitoring and
effective management. Board should be effective as its the chief decision making authority of
organization. According to Pathirawasan (2013), managers play most important role for firms
financial performance they make different corporate decisions and strategies, handle firms
assets, leverage and capital in order to make firm profitable. Cadbury (1992) suggests that board
structure is an important corporate governance attribute, which is helpful in improving the
performance of organization.
According to Adams and Mehran (2003) a larger board size can examine the
organization function more effectively and provide better management and monitoring of the
organization due to the better skills and more expertise. Large boards can more effectively
attain capital than smaller boards. However Berger et al. (1997) also found negative relation
between board size and leverage. According to research on Ghanaian firms conducted by
Bopkin, Arko and Arbor (2009) there is positive significant relationship between board size and
capital structure. According to Yermach and Ofek (1997) the firms with larger board usually
takes lower leverage because they pressurize the management to take lower debt to avoid
additional risk face by the investors.
CEO Duality means CEO also serve as the chairman of the board. Single person
performing both activities may be deteriorating for the overall structure and impact the firm
performance. Theoretically, agency conflicts can be reduced, if we separate the duties of decision
control and decision management. Fama and Jensen (1983) argue that role of CEO and
chairman should be separate, aschairman is the chief decision control authority and CEO has the
responsibility to manage business of the firm. But duality can increase power and also improve
overall judgment. CEO Duality provides broader power, authority and control to the CEO
(Boyd, 1995). So, overall mixed views are found in the literature related to CEO duality.
Pfeffer and Salanick (1978) argued that directors with greater judgment ability would
more easily overcome organizational inactivity and sluggishness and better able to execute
strategic decision. Brickley et al. (1997) argued that duality and separation both have benefits
and cost so there is no significant single relationship between duality and capital structure
because duality will be good and beneficial for some organization and it is not valuable for
other.
Composition of the Board both executive, non executive directors should be included
in the board as well as independent directors. Independent or outside director monitor the actions
of executive director and make sure that he is not exploiting share holders right. According to
Weisbach (1988), When the organization is composed of both independent and outside director,
then there would be more effective monitoring of the top management. There is also mixed
view found on that topic in literature. Some researchers find out negative relationship between
leverage and board composition because according to them the managers seek lower leveraged
when there is strong corporate governance practices. Because if there is appropriate and vigorous
monitoring then share holders rights are not being exploited and managers are more preferably
risk averse. Kyereboah, Coleman and Biekpe (2006) argues the leverage of firm is positively
related with the percentage of directors in the board.
Directors Remuneration helps to motivate the manager to make those decision that
help to maximize share holders wealth. An agency conflict arises due to the conflicts of interest
between both the managers and shareholders. In order to reduce agency conflicts and make
managers work for the interest of shareholders remuneration is provided. The compensation of
managers should be attractive enough that have the ability influence managers to maximize
shareholders wealth. Abdullah (2006) found on his research on Malaysian firms that there is
negative relationship between directors remuneration and ROA. And Wen et al. (2002) finds
that directors remuneration is negatively and insignificantly related to capital structure of
organization.
Mian et al. (1996) founds positive and significant relationship between directors
compensation and capital structure. Wen et al (2002) suggests that there is negative association
between the directors remuneration and capital structure. The other control variables used in this
research includes profitability that is calculated through ROA and tangibility of assets etc. the
larger profitability generally results in lower debt ratio. As generally more profitable firms
usually invested their capital in many profitable projects and generate funds more easily.





References
Abdullah, S 2006, Directors' remuneration, firm's performance and corporate governance in Malaysia
among Distressed Companies, Corporate Governance, vol. 6, no. 2, pp. 162 174.
Abor, J 2009, Corporate governance and financing decisions of Ghanaian listed firms, Corporate
Governance, vol. 7, no.1, pp.83 92.
Adams, R, & Mehran, H 2003, Is corporate governance different for bank holding companies? Federal
Reserve Bank of New York Economic Policy Review, pp. 123-42.
Anderson, R,C, Mansi, S A, & Reeb, D, M 2004, Board characteristics, accounting report integrity and
the cost of debt, Journal of Accounting and Economics, vol. 37, pp. 315-42.
Berger, P,G, Ofek, E, & Yermack, D,L 1997, Managerial entrenchment and capital structure decisions,
The Journal of Finance, vol. LII, no. 4, pp. 1411-38.
Bevan, A, A, & Danbolt, J 2002, Capital structure and its determinants in the United Kingdom A
decomposition analysis, Applied Financial Economics, vol. 12, no. 3, pp.159-170.
Bokpin, G, A, & Arko, A, C 2009, Ownership structure, corporate governance, and capital structure
decisions of firms: Empirical evidence from Ghana, Studies in Economics and Finance, vol. 26, no. 4, pp.
246-56.
Booth, L, Aivazian, V, Demirguc-Kunt, A & Maksimovic, V 2001, Capital structures in developing
countries, The Journal of Finance, vol. 56, no. 1, pp. 87-130.
Boyd, B, K 1995, CEO duality and firm performance: A contingency model, Strategic Management
Journal, vol. 16, no. 4, pp. 301312.
Brickley, J, Coles, J, & Jarrell, G 1997, Leadership structure: Separating the CEO and Chairman of the
Board, Journal of Corporate Finance, vol. 3, pp. 189-220.
Cadbury, A 1992, The financial aspects of corporate governance, the final report of the Committee on
the Financial Aspects of Corporate Governance, viewed on 8 June 2013
http://www.ecgi.org/codes/documents/cadbury.pdf.
Claessens, S, Djankov, S, Fan, J. P. H, & Lang, L. H. P 2002. Disentangling the incentive and
entrenchment effects of large shareholders, The Journal of Finance, vol. 57, no. 6, pp. 274-271.
Demsetz, H, & Villalonga, B 2001, Ownership structure and corporate performance, Journal of Corporate
Finance, vol. 7, no.3, pp. 209233.
Fama, E. F, & Jensen, M.C 1983, Separation of ownership and control, Journal of Law and Economics,
vol. 26, no. 2, pp. 301-325.
Fosberg, R.H 2004, Agency problems and debt financing: Leadership structure effects, Corporate
Governance, vol. 4, no.1, pp.31 38.
Fraser, D, R, Zhang, H, & Derashid 2006, Capital structure and political patronage: The case of
Malaysia, Journal of Banking and Finance, vol. 30, no.4, pp. 12911308.
Graham, J,R, & Harvey, C 2001, The theory and practice of corporate finance: Evidence from the field,
Journal of Financial Economics, vol. 60, no. 2-3, pp. 187-243.
Hovey, M 2006, Corporate governance and capital structure, Evidence of listed firms in China, School of
Business, Economics and Public Policy, University of New England, NSW 2351, Proceedings of the 2nd
International Conference on Corporate Governance Hovey.
Jensen, M 1986, Agency cost of free cash flow, corporate finance and takeovers, American Economic
Review Papers and Proceedings, no. 76, pp. 323-329.
Jensen, M, & Meckling, W 1976, Theory of the firm: Managerial behavior, agency cost and ownership
structure, Journal of Financial Economics, vol. 3, no. 4, pp. 305-360.
Joseph F, Sheridan T & Garry T 2012, An International comparison of capital structure and debt maturity
choices, Journal of Financial and Quantitative Analysis, vol. 47, no. 1, pp. 23-56.
Kester, W,C, & Kolb, R, W 1991, Capital and ownership structure: a comparison of US and Japanese
manufacturing corporation, Harvard Business School.
Kumar, J 2001, Capital structure and corporate governance, Institute of Management, Bhubaneswar,
India, pp. 751 013.
Kyereboah-Coleman, A, & Biekpe, N 2006, The link between corporate governance and performance of
the non-traditional export sector: Evidence from Ghana, Corporate Governance, vol. 6, no. 5, pp.609
623.
Liao, L, Mukherjee, T,K, & Wang, W 2012, Does corporate governance impact capital structure
adjustments?, Midwest Finance Association 2013 Annual Meeting Paper.
Main, B,G, Bruce, A, & Buck, T 1996, The Board remuneration and company performance, The
Economic Journal, vol. 106, no. 439, pp. 1627-1644.
Mehran, H 1992, Executive incentive plan, corporate control and capital structure, Journal of Financial
and Quantitative Analysis, vol. 27, no. 4, pp. 539-560.
Pakistan institute of corporate governance 2011, Survey on Board Practices in Pakistan, viewed on
June 2013, http://www.picg.org.pk/knowledge-base/reports/Survey-on-Board-Practices-in-Pakistan-
2011.pdf.
Pfeffer, J. & Salancik, G. R. (1978). Size and Composition of Corporate Board of Directors,
Administrative Science Quarterly, No. 21, pp. 218-228.
Rajan, R, & Zingales, L 1995, What do we know about capital structure? Some evidence from
international data, The Journal of Finance, vol. 50, no. 5, pp. 1421-1460.
Sanvicente, A, Z 2013, Capital structure decisions and the interaction with payout and ownership
decisions: Empirical evidence from Brazil, Insper Working Paper Series WPE 264/2011, viewed on 10
June 2013, http://en.insper.edu.br/sites/default/files/2011_wpe264.pdf.
Securities and Exchange Commission of Pakistan 2012, The codes of corporate governance report,
viewed on 19 June 2013, http://www.secp.gov.pk/CG/CodeOfCorporateGovernance_2012.pdf.
Sheikh, N,A, & Wang, Z 2012, Effects of corporate governance on capital structure: Empirical evidence
from Pakistan, Corporate Governance, vol. 12, no. 5, pp. 629641.
Shleifer, A, & Vishny, R,W 1997, A survey of corporate governance, The Journal of Finance, vol. 52, no.
2, pp.737-783.