THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE PRACTICES AND

FIRMS CAPITAL STRUCTURE IN MALAYSIA

Student Name
Supervisor Name
Faculty of Technology Management and Business
Universiti Tun Hussein Onn Malaysia
ap100362.siswa@uthm.edu.my
Abstract: Corporate Governance (CG) in Malaysia has been improved after the Asian
financial crisis in 1997. Good CG will provides companies with better financial decision,
including capital structure. An optimal capital structure is able to maximize the value of
company which is to provide profits to both, stockholders and staff. Therefore, this research is
focusing on the Top 100 public listed companies in Malaysia to investigate the relationship
between CG practices (board size and board independence) and firms capital structure which
is measured by debt ratio and debt to equity ratio. Secondary data from companys annual
report covering five year periods (2008-2012) were used. Descriptive analysis and correlation
analysis were used to examine the developed hypotheses. At the end of this study, CG
practices and the association between CG practices with the firms capital structure among
these Top 100 companies will be revealed.
Keywords: Corporate governance, capital structure, Top 100 public listed companie s
1.1 Introduction
After the 1997 Asian Financial Crisis, the
adoption of the High Level Finance
Committee signs a significant milestone in
Malaysias journey to address corporate
governance issues (Securities Commission
Malaysia, 2011). Poor execution of
corporate governance will result in heavy
burden to minority shareholders, in an
emerging markets (Che Haat et al., 2008).
Thus, good corporate governance
practices will assist companies to measure
the sustainability of performance and
profitability of the firms operation such as
decisions on long term investment
(Securities Commission Malaysia, 2011).
There are some components of corporate
governance that will affect the capital
structure decision in the company. For
example, does the board size and board
independence have any association with
the capital structure of the firm? This
research is therefore attempting to
investigate the relationship between the
corporate governance practices and firms
capital structure.
1.2 Research background
Malaysian government decided to
implement corporate governance that will

enhance the performance and quality of

good corporate management practices in
Malaysias companies after the Asian
Financial Crisis in 1997. The recognition
of corporate governance was significantly
evidenced by the released of the
Malaysian Code on Corporate Governance
(MCCG) by committee in year 2000. In
2011, Securities Commission Malaysia has
published the Corporate Governance
Blueprint. This is followed by an updated
MCCG which come into effective in
December 2012. Therefore, corporate
governance is a significant issue in
Malaysia economy.
Capital structure plays an important
role in maximizing the value and
performance of the company. Effective
management of capital structure will help
the company to gain competitive
advantage and increace the profitability of
company. The capital structure decision of
the company was proven to be associated
with the companys corporate governance
practices. For example, board size of the
company will influence the company
capital structure decision (Lawal, B.,
2012). Besides, more independent
directors in a company will help to reduce
the amount of debt for the provision of
finance which is because of the presence
1

of more effective supervision and

management (Vakilifard et al., 2011).
1.3 Problem statement
Corporate governance is a significant
element to success in a company
especially after the Asian Financial Crisis.
A good corporate governance will assist
company reduce the emerging market
vulnerability to financial crises, reinforces
property rights, reduces transaction costs
and the cost of capital, and leads to capital
market development. On the other hand,
because funding is scarce, efficient
allocation of the scarce funds is crucial. In
an economic sense, corporate governance
helps in this situation as it is an important
factor in determining which projects that
are higher in returns, and which one of
them will take a higher priority (Hadi et
al., 2007).
Reviews on previous literatures shows
that there are limited number of studies
focuses on the link between firm
corporate governance practices and capital
structure. Underlying issue here was; is
there are any relationship between firms
corporate governance practices and the
firms capital structure? Therefore, clear
understanding on such issue in Malaysia is
needed. This study is trying to investigate
the relationship between the corporate
governance practices and the firms capital
structure in Malaysia.
1.4 Research questions
Research questions of this study are as
follows:
1. What is the practice of corporate
governance among Top 100 public
listed companies in Malaysia?
2. What is the relationship between
firms corporate governance practices
with firms capital structure?
1.5 Research objectives
Research objectives of this study are as
follows:

1. To
investigates
the
corporate
governance practices among Top 100
public listed companies listed in Bursa
Malaysia.
2. To study the relationship between
firms corporate governance practices
with firms capital structure.
1.6 Significance of study
This research will provide better
understanding
on
the
corporate
governance practices in Malaysia among
public listed companies. Besides that, this
research gives further information about
the importance of having well and
effective
board
size
and
board
independence as well as their association
with the firms capital structure. Since
there are limited number of studies focuses
on the link between firms corporate
governance practices and their capital
structure, therefore, this study can provide
some contribution in term of addition to
the knowledge of this field in Malaysia.
1.7 Scope of study
This study is focusing on investigating the
corporate governance practices among
selected sample of public listed companies
in Malaysia. Data are gathered using
secondary data available from Bursa
Malaysia website, company website and
also Thomson Datastream. These data are
taken from Top 100 public listed
companiess (PLCs) annual report in
Malaysia over the period of 2008 to 2012.
These Top 100 PLCs were selected
based on the performance on the market
capitalization. The reason for using the
Top 100 PLCs as the sample of study was
because these companies had shown the
best performance and standard position
stand in the market. Thus, these Top 100
PLCs can represent the entire companies
listed in Bursa Malaysia and also represent
the overall performance of Malaysian
economy, in term of market performance.
Within the selected sample of Top 100
PLCs, the database that will be analyzed in
this study will only comprise of those
companies with complete data on
corporate
governance
and
firms
performance from 2008 to 2012. Those
2

companies
with
uncompleted
or
insufficient data will be omitted and will
not be replaced.
2.0 LITERATURE REVIEW
2.1 Introduction
The influential elements of corporate
governance that have an association with
the companys capital structure need to be
investigated. In this chapter, focuses are
more on the definition of corporate
governance and capital structure of the
company. These two variables are the
fundamental of this study and the
relationship between these two variables
will be further discussed.
2.2 Corporate Governance
The corporate governance is defined as
the process and structure used to direct
and manage the business affairs of the
company towards enhancing business
prosperity and corporate accountability
with the ultimate objective of realizing
long-term shareholder value whilst taking
into account the interest of other
stakeholders (Securities Commission
Malaysia, 2011).
Corporate governance mechanisms
have two differences perspective. These
two models are internal perspective and
external perspective (Hadi et al., 2007).
Another mechanism was the market-based
governance model (or Anglo American
model) and the control model (or FrancoGermany) (Bai et al., 2004). The
Malaysian governance reform agenda has
suggested the corporate governance
mechanisms that applied by the Malaysian
corporate sectors. For example, ownership
structure, board structure (which include
CEO duality, board size, board
independence,
professionalism
or
qualifications), board activity (which
include board meeting and board
committee), remuneration, transparency
and disclosure, and alliances or mergers
(Hadi et al., 2007). The following sections
will further discuss the chosen indicators
for corporate governance practices used in
this study.

2.2.1 Board size

Based on the Malaysian Code on
Corporate Governance (2007), it was
stated that every board should examine
its size, with a view to determining the
impact of the number upon its
effectiveness. There are some factors that
a company needs to consider in
determining the number of seats in a
board. The changing in environments or
circumstances and needs of the company
in term of size, scope or geography; the
executive and non-executive directors and
the independent elements of non-executive
directors need to be balanced (balance
composition in a board will ensure there is
no individual or small group of individual
will dominate the decision making); and
others.
According to the International
Business Machines Corporation (IBM)
Board Corporate Governance Guidelines
(2008), a number of between 10 to 14
directors on the Board is optimal. This
approach was flexible depend on the
circumstances and qualifications of
proposed candidates. The MCCG has
highlighted that the need for a board to
determine the appropriate size required for
the effective discharge of its roles and
responsibilities for the benefit of the
company and its business (BURSA
MALAYSIA, 2007).
2.2.2 Board Independence
Board independence is also known as
independence director or non-executive
director. They are defined as one who is
independent of management and free from
any business or other relationship that
could interfere with the exercise of
independent judgement or the ability to act
in the best interests of a listed company.
The purpose of the independent directors
to take part on the board is to ensure that
objective decision-making of the board is
achieved and that no single party can
dominate the decision in the company
(Securities Commission Malaysia, 2011).
MCCG (2007) also stated that the
board should disclose on an annual basis
whether one-third of the board is
independent, and in circumstances where
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the company has a significant shareholder,

whether it satisfies the requirement to
fairly
reflect,
through
board
representation, the investment of the
minority shareholders in the company.
The positive aspect of the board
independence will help companys
survival during the thrift crisis due to the
greater proportion of independent directors
on the board. Besides, they will help the
company increase the performance and do
the better decision as they more
understand the outside situation (Hadi et
al., 2007)

suppliers, lenders, creditors and obligators

have committed to the company versus
what
the
shareholders
have
committed. According to Kirti Madan
(2007), the debt to equity ratio shows the
proportion of debt funds to equity. The
higher the debt to equity ratio, the higher
the leverage. The formula for the debt to
equity ratio is total liabilities over the
shareholders equity.

2.3 Capital Structure

The corporate governance practices had

growth vital in Malaysias companies in
order to have better performance in the
marketplace. Hence, to understand the
financial development of a company, it is
necessary to determine their financial
practices or capital structure decision. The
process or system used to manage the
company will affect the capital structure
decisions (Abor, J., 2008). Therefore,
underlying issue of the corporate
governance practices of a firm will
associate the firms capital structure.
There are some studies that have
examined the relationship between
corporate governance and capital structure
which comes with mixed results. The
company which has the bigger board can
effectively monitor and manage the
actions of management and provides better
expertise and performance (Adam and
Mehran et al., 2003). Conversely, Lipton
and Lorsch (1992) found that large board
size is less effective compared with small
board size because some directors will put
less effort than others.
In addition, some research had shown
that leverage is significantly lower when
the friction of independent directors is
small (Berger et al., 1997). Based on the
study by Pfeffer in 1972, there is a
significant positive relationship between
the proportion of board independent and
capital structure. Whereas, Anderson et al.
(2004) reported that there is a negative
relationship between board independent
and capital structure.

Capital structure is defined as the specific

mix of debt and equity a firm uses to
finance its operations (Abor, J., 2008). The
result of preview studies had shown that
capital structures are an important
determinant of a companys value.
External sources of capital structure can be
classified under two main subject which is
equity and debt (Madan, K., 2007).
Measurement of capital structure usually
includes debt and debt to equity ratio
(Pratheepkanth, P., 2011). These two
indicators were chosen to be used in this
study and discusses in the following
sections.
2.3.1 Debt Ratio
This ratio compares companys total debt
to its total assets, which is used to gain a
general idea as to the amount of leverage
being used by a company. Debt ratio will
help investors looking for a quick take on
a company's leverage. It gives users a
quick measure of the amount of debt that
the company has on its balance sheets
compared to its assets. The more debt
compared to assets a company has, which
is signaled by a high debt ratio, the more
leveraged it is and the riskier it is
considered to be.
2.3.2 Debt to Equity Ratio
The debt to equity ratio is another leverage
ratio that compares a company's total
liability to its total shareholders' equity.
This is a measurement of how much

2.4 The Relationship between Corporate

Governance Practices and Firms
Capital Structure

3.0 METHODOLOGY
4

3.1 Introduction
This chapter discusses the methods that
applied to carry out this study. This part
included the research framework, data
collection, and data analysis. The
discussions of the research methodology
will provide better understanding of the
appropriate research approach to be
implemented.
3.2 Research Framework
The indicators of corporate governance
(independent variable) in this research
were focused on board size and board
independent. Whereas, the indicators of
capital structure (dependent variable) were
debt ratio and debt to equity ratio. Overall,
the theoretical framework of this research
was shown below:
Corporate
Governance:
Board size
Board
independence
Independent
variable

Firms Capital
Structure:
Debt ratio
Debt to equity

Dependent
variable

Figure 1: Research Framework Model

3.3 Data collection
This research uses secondary data which is
compiled from the companys annual
report to investigate the relationship
between corporate governance practices
and firms capital structure. Top 100
PLCs annual report will be taken from
Bursa Malaysias website, company
website and also Thomson Datastream.
The most recent 5 years annual report will
be analyzed, which are from year 2008 to
2012. The data collected consists of
company name, year, board size, number
of board independence, total asset, total
liability, and shareholders equity.
3.4 Data Analysis
Data analysis is one of the important
elements of the research. After the data

being collected, analysis data process will

be started in order to determine and find
out the result and proves the hypothesis
being accepted or rejected. The research
data will be analyzed using Statistical
Package for Science Social (SPSS). The
descriptive analysis and correlation
analysis were used to prove the
hypothese.
Descriptive analysis was used to
describe the original characteristics of the
data set and act as the key to summarizing
variables. Descriptive analysis also present
measures of central tendency, dispersion,
and distribution shape, such measures vary
by data type (nominal, ordinal, interval,
ratio) and are standard calculations in
statistics programs. The objective of
descriptive analysis is to describe and
summarize the characteristics of the
researchs sample (Leary, Z.O., 2010).
The objective of inferential analysis
was to sketch conclusions that extend
beyond the data or sample. Correlation
analysis can be used to test various
hypotheses about the relationship between
different variables or to estimate
characteristics of a population from
sample data. In other words, correlation
statistics consent to generalizing (Leary,
Z.O., 2010). Besides, the correlation
analysis was referred to determine the
strength of the relations between two
variables. It has the ranges from +1 to -1.
The closer to the absolute value is to 1,
thus, the stronger the relationship or
known as positive relationship. When the
correlation coefficient is zero, it indicates
that there is no relationship between two
variables. Whereas, if the value is negative
then there is a negative correlation.
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