Description
This paper aims to investigate whether firm-level corporate governance has an influence on
the equity financing patterns in an emerging economy such as Bangladesh
Journal of Financial Economic Policy
Corporate governance and equity finance: an emerging economy perspective
Faizul Haque
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To cite this document:
Faizul Haque , (2015),"Corporate governance and equity finance: an emerging economy
perspective", J ournal of Financial Economic Policy, Vol. 7 Iss 3 pp. 233 - 250
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Corporate governance and equity
fnance: an emerging economy
perspective
Faizul Haque
Department of Accountancy, Economics and Finance,
Heriot-Watt University Dubai Campus, Dubai International Academic City,
Dubai, UAE
Abstract
Purpose – This paper aims to investigate whether frm-level corporate governance has an infuence on
the equity fnancing patterns in an emerging economy such as Bangladesh.
Design/methodology/approach – The regression framework uses a questionnaire survey-based
corporate governance index (CGI) comprising fve dimensions – ownership structures, shareholder
rights, independence and responsibilities of the board and management, fnancial reporting and
disclosures and responsibility towards stakeholders. In addition, a number of semi-structured
interviews have been carried out with the relevant stakeholders.
Findings – The results suggest a statistically signifcant positive relationship between CGI and equity
capital and, thus, confrm the prediction of the agency theory.
Research limitations/implications – This study does not address endogeneity and reverse
causality issues with respect to the relationship between CGI and equity fnance.
Practical implications – Firms should improve their legal compliance and voluntary activism in
corporate governance matters to ensure increased access to equity fnance.
Originality/value – This study is among the frst to examine the relationship between overall
corporate governance quality and equity fnance of a frm from the perspective of a bank-based
emerging economy.
Keywords Bangladesh, Agency theory, Corporate fnance and governance, Equity fnance
Paper type Research paper
1. Introduction
A frm’s ability to persuade investors about the frm’s governance quality appears to
infuence the equity fnancing of a frm. Better corporate governance and associated
stronger shareholder rights reduce agency costs (Gompers et al., 2003), which in turn
enhance a frm’s ability to gain access to equity fnance. While many studies (Haque
et al., 2011; Drobetz et al., 2004) investigate the infuence of corporate governance on debt
fnance or on cost of equity capital, the literature on the empirical relationship between
frm-specifc corporate governance and frm’s equity fnance appears to be limited.
JEL classifcation – G32, G34, G38, O16
The author gratefully acknowledges the helpful comments fromthe anonymous reviewers and
the editors. An initial version of this paper was presented at an International Conference on
Corporate Governance at BirminghamBusiness School in 2006. The author thanks the conference
participants, Colin Kirkparick and Thankom Arun for their valuable comments.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
Corporate
governance
and equity
fnance
233
Received23 November 2014
Revised3 February2015
3 March2015
Accepted12 March2015
Journal of Financial Economic
Policy
Vol. 7 No. 3, 2015
pp. 233-250
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-11-2014-0070
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Several studies (Céspedes et al., 2010; Patibandla, 2006) consider individual governance
issues such as ownership or management structures, rather than overall frm-level
governance practices. No study to date focuses on the linkage between corporate
governance and equity fnancing in Bangladesh.
This study contributes to the existing agency theory-based literature on the
relationship between corporate governance and equity fnance from the perspective of
an emerging economy such as Bangladesh, where the capital market and the corporate
sectors are very weak, and the fnancial system is predominantly bank-based.
Bangladesh represents an interesting case for this study because the country’s fnancial
sector has been experiencing reform initiatives since 2001. However, little is known
about the effect of fnancial sector reform on capital market development in terms of
relatively better corporate governance practices and better investors’ confdence. This
study is likely to have important policy implications in relation to the impact of fnancial
sector reform that was undertaken to strengthen the capacity building of the capital
market. This paper investigates the infuence of frm-level governance quality on equity
fnance of 101 non-fnancial listed frms in Bangladesh.
Another important motivation of this study is to measure overall corporate governance
practices of afrmrather thanthe individual governance component. This is because several
inter-related factors including the ownership pattern, independence and responsibilities of
the board and management, transparency and accountability and responsibility towards
stakeholders tend to infuence frm-level corporate governance. This study uses ordinary
least square (OLS) regression to examine the effect of a frm’s overall governance quality
measuredthroughacorporategovernanceindex(CGI). Thefndingsof thestudysupport the
prediction of the agency theory, with a statistically signifcant positive association between
frm-level corporate governance and the frm’s equity fnance.
The organization of the paper is as follows: Section 2 reviews the available literature
and Section 3 presents the research question and empirical model. Section 4 presents the
empirical analysis, including the data, the patterns capital structure and ownership, the
univariate analysis and the regression results. Section 5 analyses the study results and
Section 6 concludes this paper.
2. Literature review
The literature on the fnance-related aspect of corporate governance is primarily based
on the agency theory. While Jensen and Meckling (1976) refer to two types of agency
conficts in a frm(i.e. between the shareholders and managers, and the shareholders and
creditors), Shleifer and Vishny (1997) suggest that a confict of interests can occur
between large controlling block holders and minority shareholders. This is particularly
relevant to the Asian developing economies, where large controlling shareholders can
cause enormous agency problems through direct or indirect expropriation of minority
shareholder rights. Céspedes et al. (2010) also observe that in Latin America, asymmetric
information problem exists between large shareholders and the rest of fnancing
providers (i.e. small shareholders and debtholders). This eventually results in poor
governance quality of a frm.
However, empirical literature on the relationship between frm-level corporate
governance and the frm’s equity fnancing pattern tends to be limited. Among others,
La Porta, Lopez-de-Silanes, Shleifer and Vishny, henceforth La Porta et al. (1997) and
Claessens (2003) address the signifcance of frm- (and/or country) level governance to
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the investors’ improved confdence and the frm’s increased access to equity fnance.
Gugler et al. (2003) and Gilson (2000) also mention that good governance practices
infuence higher-equity investment, regardless of a country’s legal institutions. Shleifer
and Vishny (1997) argue that a frm is likely to get external fnance not only because of
the reputation of the capital market and excessive investor optimism, but also due to
positive assurances provided by the corporate governance system. Investors are likely
to provide more fnance if they are given greater assurance (through better governance)
of a fair return on their investment.
Alternatively, as Shleifer and Vishny (1997) mention[1], the controlling shareholders’
expropriation of minority shareholder rights can cause higher agency cost of equity,
leading to lower equity funds from external sources. Likewise, controlling owners of
poorly governed frms are likely to prefer readily available bank debt to meet the frm’s
fnancing needs, whilst retaining absolute ownership and control over the frm.
Apart from corporate governance, several other frm-specifc factors such as frm
size, age, proftability, growth, asset tangibility and debt ratio tend to infuence a frm’s
equity fnancing pattern. Rajan and Zingales (1995) and Kumar (2005) argue that lower
informationasymmetryproblems betweenthe insiders andoutside shareholders of the large
frms exert a positive infuence on equity fnance, due to lower agency cost of equity.
However, Dittmar and Thakor (2007) argue that larger frms enjoy lower cost of debt and
may prefer debt to equity for this reason. Schäfer et al. (2004) regard that the age of the frm
is animportant determinant of the frms’ equityfnancingpattern, andargue that the degree
of asymmetric information is extremely high between the investor and a frm in its early
stage of development. Nonetheless, Ramano et al. (2000) argue that developing (i.e. younger)
frms tend to rely on equity, due to their diffculty in raising debt.
Proftability tends to be inversely associated with the equity fnancing pattern, as
Dittmar and Thakor (2007) assert that highly proftable frms generate high retained
earnings and use this to fnance projects internally. This is because perceived confict of
interests between the insiders and outside investors infuences a frm to select retained
earnings over external fnancing (Suto, 2003). Moreover, the asymmetric information
problems and associated high cost of raising equity makes equity as the least favoured
fnancing option (Du and Dai, 2005). However, proftability can be positively associated
with equity fnance, as the outside investors might be inclined to invest more in
proftable frms in the hope of higher future return on equity. Likewise, Lombardo and
Pagano (2002) argue that proftability increases the marginal productivity of capital that
causes an outward shift in the proftability schedule, leading to an increased demand for
equity capital.
Myers (1977) and Rozeff (1982) regard growth opportunity as an important
determinant of capital structure decisions. Firms with higher growth opportunities are
more likely to rely on equity fnance[2] due to the potential bankruptcy or fnancial
distress risks associated with corporate leverage (Du and Dai, 2005). Nonetheless, the
controlling shareholders’ intention to retain ownership and control right is likely to
drive growing frms to rely more on debt rather than equity. This is especially noticeable
in the bank-based fnancial systems in emerging countries, where obtaining both long
and short-term bank loans is relatively easier.
Dittmar and Thakor (2007) argue that asset tangibility is an important determinant of a
frm’s choice of equity (versus debt). Asset tangibility is presumed to have a negative
association with equity fnance, as Rajan and Zingales (1995) suggest, frms with more
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tangible assets are more likelyto use debt fnance. This is because the relative importance of
collateral value in the equity contract is likely to be lower than that of a debt contract. The
debt ratio can also be an important determinant of a frm’s equity fnancing pattern, as
Dittmar and Thakor (2007) refer to the trade-off theory which suggests that an overvalued
frmis more reliant onequityover debt. However, a frm’s higher access (or reliance) ondebt
fnance may cause a negative infuence on equity fnance.
3. Hypothesis and model
This paper is based on the prediction of the agency theory in relation to the infuence of
corporate governance on equity fnance. The agency problems associated with the
confict of interests in family controlled frms is particularly relevant to the corporate
governance setting of a developing economy, where controlling family or shareholders
cause enormous agency costs through various forms of expropriation of external
shareholder rights. This paper addresses the following hypothesis:
H1. Corporate governance quality is positively associated with the frm’s equity
fnancing pattern.
In the absence of adequate literature on corporate governance and the frm’s equity
fnance, it is rather diffcult to identify a dependent variable to denote the proportion of
equity in a frm’s capital structure. This study follows Wu et al. (2007) in using the ratio
of shareholders’ equity (i.e. book value of equity capital) to total assets as an equity
fnancing measure. However, the inclusion of retained earnings in the shareholders’
equity is likely to undermine the suitability of this variable. This problem can partly be
resolved by taking the ratio of market value of equity (i.e. market capitalization) to total
assets as a proxy for the frm’s equity fnance.
Nonetheless, as La Porta et al. (1997) argue, taking total market capitalization of a
frm with signifcant family shareholding is likely to overestimate the proportion of
equity raised from external sources. Following La Porta, Lopez-de-Silanes, Shleifer and
Vishny (LLSV), this study uses the ratio of market capitalization held by outsiders to the
frm’s cash fow (identifed as equity-to-cash) as one of the frm-level equity variables.
The amount of market value of equity owned by the outside shareholders is the total
market capitalization multiplied by the proportion of equity held by non-controlling
shareholders[3]. The cash fowis the sumof the non-cash charges (e.g. depreciation and
amortization) and the net income after taxes. In addition, this study uses both the book
value of equity to total assets (indicated by book-to-assets), and the market value of
equity to total assets (denoted as market-to-assets) to investigate whether the infuence
of corporate governance remains consistent across different equity measures.
Taking these alternative equity fnancing measures as dependent variables, this
study develops the following regression model:
Equity Finance (?) ?
? ? ?
1
(CGI) ? ?
2
(Concentration) ? ?
3
(Size)
??
4
(Profitability) ? ?
5
(Historical growth)
??
6
(Growth potential) ? ?
7
(Tangibility) ? ?
8
(Age)
??
9
(Debt ratio) ? ?
10
(Industry dummies) ? ?
(1)
This cross-sectional model incorporates frm-level CGI as the main test variable, with
higher CGI specifying better governance quality of the frm. Better corporate
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governance tends to infuence a frm’s capital structure decisions towards equity
fnance. The model also includes ownership concentration (i.e. percentage of top fve
shareholdings) as an additional governance variable. As mentioned above, the large (or
concentrated) shareholding is likely to have an inverse effect on equity fnance.
Based on the review of literature on the determinants of equity fnance, the
regression framework also includes several frmcharacteristics as control variables.
These include, frm size (measured as the natural logarithm of assets), proftability
or return on assets (the ratio of net income after taxes to total assets), historical
growth (average asset growth rate over a period of past three or fve years), growth
potential (Tobin’s Q), asset tangibility (the ratio of fxed assets-to-total assets), age
(number of years as a listed frm), debt ratio (long term debt-to-total assets) and the
industry dummies based on four digit Standard Industrial Classifcation (SIC) codes.
Agrowing body of literature puts forward the issue of endogeneity with reference to
the association between corporate governance and fnancial performance. Among
others, Gompers et al. (2003) mention that the difference in fnancial performance
amongst frms might be driven not only from the governance provisions, but also from
other unobservable or diffcult-to-measure frm characteristics associated with the
governance quality. Himmbelberg et al. (1999) observe that a large fraction of the
cross-sectional variation in managerial ownership is explained by unobserved frm
heterogeneity or fxed-frm effect. Whilst the study does not address this issue, the OLS
regression framework is intended to mitigate the omitted variable problem by
incorporating several frm-specifc characteristics and industry dummies as control
variables[4].
Among others, Demsetz and Villalonga (2001) refer to reverse (or two-way) causality
as another important frm-level endogeneity issue. For instance, Klapper and Love
(2004) mention that frms with greater need for external fnance are more inclined to
adopt better governance practices (to ensure low cost of capital), rather than vice-versa.
The present single equation model does not address this causality issue[5]. This remains
to be a caveat of the study with respect to the causal relation between corporate
governance quality and equity fnance.
4. Empirical analysis
This section explains the data including the CGI, followed by the ownership structures
and equity fnancing pattern, the univariate analysis and the regression results.
4.1 The data
This cross-sectional study is based on the survey data on corporate governance and the
published data on equity fnancing pattern in Bangladesh. Amongst the 186
non-fnancial listed frms of the prime exchange of the country known as the Dhaka
Stock Exchange (DSE), 101 frms responded to the survey (carried out by the author in
2004), with the response rate being approximately 55 per cent. The respondents of the
questionnaire were the CEOs, company secretaries, executive board members, fnance
directors, chief accountants or other senior executives depending on the availability and
accessibility. The sample frms capture nearly 96 per cent of the total market capitalization
(MC) of all non-fnancial frms, and 45 per cent MCof the DSE[6]. The data on equity fnance
and other frm characteristics are collected from the annual reports of the sample frms for
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the latest fnancial year (2004-2005) and the DSE monthly reviews. In addition, fve
semi-structured interviews have been carried out with the relevant stakeholders.
Given the widely established concern about the reliability of the data, especially in
the context of a developing country such as Bangladesh, the CGI is based on a
questionnaire survey in an effort to improve the level of accuracy of the governance
data. Inaddition, the fnancial dataare basedonthe companyandDSEpublications. Whilst
this remains amethodological weakness, it appears that there is noother optionbut toaccept
the publiclyavailable datathat are basedonanoutdateddisclosure framework. As Ethridge
(2004, p. 151) argues, “We effectively assume that secondary (i.e. published) data are
error-free because we have no defense for using it if we do not make that assumption”.
Another potential drawback of the study is the usage of cross-sectional data in empirical
estimation. Given the diffculty in getting access to data in an emerging economy like
Bangladesh, questionnaire survey appears to be the only alternative to collect frm-specifc
governance data. However, it is not possible to conduct another survey (to construct a panel
dataset) due to the time and fnancial constraints.
4.1.1 Corporate governance index. To quantify the governance-related issues, this
study constructs a CGI, consisting of fve individual governance components, namely,
the ownership pattern (sub-index 1), shareholder rights (sub-index 2), independence and
responsibilities of the board and management (sub-index 3), fnancial reporting and
disclosures (sub-index 4) and responsibility towards stakeholders (sub-index 5). This
study follows, among others, Black et al. (2006) and Klapper and Love (2004) in selecting
the individual elements of CGI, although several elements are modifed to make the
index compatible with the legal and regulatory issues in Bangladesh. The frm-specifc
scoring of the corporate governance practices in Bangladesh might not be comparable to
international governance ratings. Given the drawbacks of weak legal and regulatory
structure of the country, this study is intended to measure (and rank) the frm’s relative
voluntary activism and/or legal compliance in corporate governance matters.
The CGI and its sub-indices incorporate a total of 41 dichotomous variables (attached
in the appendix). Each variable in the sub-indices had a value 1 or 0, with 1 being the
compliance with better corporate governance practices or 0 otherwise. A sub-index is
the sum of the values of all variables within that index, divided by the number of
non-missing variables. Afterwards, the ratio is multiplied by 20 to facilitate comparison
of the sample frms and to assign equal weight to each sub-index (see also Black et al.,
2006). This has led to the value of the resulting sub-index between 0 and 20. Finally, the
CGI is the sum of the values of all fve sub-indices. The CGI of each sample frm carries
a value between 0 and 100, with the higher score denoting a frm’s better governance
quality. The study assigns equal weight to all of the fve sub-indices, as there is no
established theoretical model of assigning different weights to different sub-indices or
equal weight to each of the variables within the sub-indices.
One potential methodological concern is the validity of CGI as a measure of corporate
governance quality of a frm. This study uses Cronbach’s alpha to test the ability of the
instrument (e.g. CGI) to measure what is it is supposed to measure (see Saunders et al.,
2009). The Cronbach’s alpha of all fve sub-indices of CGI is 0.806, which indicates a high
level of internal consistency (e.g. internal validity) of individual corporate governance
issues that constitute the CGI. Moreover, as mentioned above, this study follows, among
others, two of the widely cited papers (Black et al., 2006; Klapper and Love, 2004) in
selecting the individual elements of CGI. This is likely to address concerns on content
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validity, e.g. whether the elements of CGI provide adequate coverage of the quality of
corporate governance of a frm. It is important to mention that CGI data are based on a
structured questionnaire survey administered by the author through face-to-face
interactions with the respondents. The author spent six months in Bangladesh to
conduct this survey as part of the author’s doctoral research programme fromone of the
top Russell group Universities in the UK. The author complied with all required policies
of that University in relation to research ethics for PhD students.
The distribution of CGI of 101 non-fnancial frms reveals that the mean (median)
value of the CGI is 40.84 (41.67), whilst the standard deviation is 21.23. The standard
deviation implies a higher degree of dispersion between the governance scores of many
listed frms and the average governance index. One of the reasons of this distribution is
the widespread difference in governance qualities among the sample frms in various
categories (e.g. foreign versus local).
Table I shows the mean distribution of CGI and fve sub-indices across various
industrial categories. The table shows that the quality of corporate governance amongst
the foreign frms is very high in relation to the locally controlled frms. This is because
the former seems to follow internationally recognized best practices in many aspects of
governance. The presence of foreign frms has also caused higher scores in several
sectors such as electrical equipments, leather, chemical and tobacco.
4.2 Existing ownership structure and external equity fnancing
Table II shows the capital structure and shareholding patterns of non-fnancial listed
frms in Bangladesh. Panel-1 of the table shows that debt fnancing dominates the frm’s
fnancing pattern, with the proportion of debt in the total assets being around 69 per
cent. The controlling shareholders[7] provide roughly 16 per cent of the total assets
as equity funds, whilst external shareholders (e.g. fnancial institutions and
minority shareholders) contribute the remaining 15 per cent. The table also shows
that long-termdebt constitutes one-ffth of the total assets. Altogether, non-fnancial
frms in Bangladesh tend to have a high degree of reliance on short-term bank debt
instead of equity or long-term debt. Given the poor state of default culture in the
banking sector of Bangladesh, this study result does not seem to be surprising
because it is easier for the frms to get bank loans without facing any stringent
punishment for being defaulted.
Panel-2 shows that the largest shareholder owns around 31 per cent equity in the
sample frms. The average ownership stakes of the top fve and top ten shareholders
are 57 and 65 per cent, respectively. This pattern of shareholding portrays a highly
concentrated pattern of ownership in the corporate sector of Bangladesh. Overall,
foreign frms show much more concentrated shareholding (generally by the parent
company) than their local counterparts in all concentration measures.
Panel-3 of the table shows that the founding family and its associates (with whomthe
former has personal, business or political affliations) exert direct control over the frm
by owning around 36 per cent of the shares. The table also depicts that the fnancial
institutions[8] and minority (or dispersed) shareholders own around 20 and 30 per cent
stakes, respectively. Financial Institutions and general shareholders tend to acquire
shares through primary and/or secondary equity markets. The table further
demonstrates that the government owns around 5 per cent shares in the sample frms,
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2
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a
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a
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2
0
1
6
(
P
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)
Table I.
Mean values
corporate governance
index across
industries
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JFEP
7,3
240
D
o
w
n
l
o
a
d
e
d
b
y
P
O
N
D
I
C
H
E
R
R
Y
U
N
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V
E
R
S
I
T
Y
A
t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
although several listed frms are signifcantly state-owned. While some of the country’s
well-governed listed frms are owned mainly by foreign corporations, the average level
of foreign shareholding is roughly 9 per cent.
4.3 Univariate analysis
Table III presents the t-test and correlation matrix for corporate governance and equity
fnancing measures. Following Gompers et al. (2003), this study uses governance scores
to construct two extreme portfolios such as the repressive portfolio (i.e. frms with poor
governance quality, with CGI ?34) and moderate portfolio (i.e. better governed frms,
with CGI ?48). Both portfolios represent the upper (33 frms) and lower (33 frms) third
of the sample. Panel-1 of Table III shows that better-governed (i.e. moderate portfolio)
frms have relatively higher level of equity fnance than the frms in the repressive
portfolio. The table also shows that the differences in book-to-assets, market-to-assets
and equity-to-cash between these two portfolios are statistically signifcant.
Panel-2 of the table shows that the three proxy measures of equity fnance (columns
1 through 3) are positively related with the CGI and its sub-indices. Interestingly,
positive correlations between equity-to-cash and fve governance indices suggest that
good-governed frms tend to have higher level of equity from the external sources. The
univariate analysis, thus, suggests that corporate governance quality does have an
infuence on the frm’s equity fnancing pattern.
Table II.
Sector-wise
distribution of capital
structure, ownership
concentration and
types of ownership
Capital structure and
ownership
Manufacturing
(%)
Non-fnance
service (%)
Foreign
(%)
Local
(%)
Total
(%)
Panel-1: capital structure
i. Total debt 71.50 39.24 47.75 71.28 68.95
Long-term debt 21.50 8.76 9.14 21.55 20.32
Short-term debt 50.00 30.48 38.61 49.73 48.63
ii. Shareholders’ equity 28.50 60.76 52.25 28.72 31.05
Sponsors’ funds 14.22 32.30 36.97 13.76 15.57
External equity 14.28 28.46 15.28 14.96 15.48
Total (i ?ii) 100 100 100 100 100
Panel-2: ownership concentration
i. Largest 31.50 28.30 62.60 27.80 31.20
ii. Top 5 57.00 51.80 82.90 53.70 56.60
iii. Top 10 65.40 63.10 86.20 62.90 65.20
Panel-3: types of ownership
i. Controlling Owners 34.79 46.91 3.59 39.27 35.74
ii. Financial Institution 20.69 11.88 15.52 20.48 20.00
iii. Public(dispersed) 29.40 34.96 13.72 31.62 29.84
iv. Government 5.58 – 0.44 5.66 5.14
v. Foreign 9.54 6.25 66.73 2.97 9.28
Total (i through v) 100 100 100 100 100
Sample Size 93 8 10 91 101
Source: Questionnaire survey data
241
Corporate
governance
and equity
fnance
D
o
w
n
l
o
a
d
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d
b
y
P
O
N
D
I
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S
I
T
Y
A
t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
4.4 Regression results
Table IV presents the OLS regression results of the relationship between corporate
governance and three alternative measures of equity fnance, namely, equity-to-cash,
book-to-assets and market-to-assets. Column 1 shows that the main treatment variable
(e.g. CGI) enters with a statistically signifcant positive coeffcient in the regression of
equity-to-cash. In addition, age, frm size and debt ratio have statistically signifcant
negative coeffcients. After controlling for industry dummies in Column 2, the
regression results remain unchanged, with an exception to debt ratio that turns out to be
insignifcant. Also, proftability turns into a statistically signifcant positive coeffcient.
Column 3 presents regression results with ownership concentration as an additional
governance variable. The regression coeffcients for the CGI and other explanatory
variables remain unaltered[9], although the debt ratio turns out to be signifcant. The
estimation of the same specifcation with the industry dummies in Column 4 brings
almost identical results, with the debt ratio turning out to be insignifcant.
Column 5 presents similar specifcation results with book-to-assets as the dependent
variable. The estimation results show that the CGI, being the only governance variable,
maintains a statistically signifcant positive sign. Amongst the control variables,
proftability and age maintain statistically signifcant positive and negative signs,
respectively. The inclusion of ownership concentration as an additional governance
variable in Column 6 does not change the regression signs, with the new governance
variable remaining negative and insignifcant. Columns 7 and 8 of Table IV show
identical specifcation results (with and without the concentration measure), with
market-to-assets as the dependent variable. However, growth potential and debt ratio
turn out to be statistically signifcant.
Overall, the adjusted R
2
values of all alternative specifcations suggest that the model
has a better explanatory power in estimating the variability in equity fnance, including
Table III.
T-test and
correlation matrix for
corporate governance
and equity fnancing
measures
Equity variables
Book-to-assets Market-to-assets Equity-to-cash n
1 2 3 4
Panel-1: mean ratios
All 0.31 0.66 2.89 101
Moderate 0.50 1.28 4.08 33
Repressive ?0.03 0.19 1.42 33
Difference (t-statistics) 0.54*** 1.09*** 2.66*
Panel-2: correlation with CGI and sub-indices
CGI 0.30*** 0.69*** 0.44*** 101
Sub-1 0.21** 0.21** 0.08 101
Sub-2 0.23*** 0.68*** 0.42*** 101
Sub-3 0.08 0.50*** 0.25*** 101
Sub-4 0.28*** 0.64*** 0.43*** 101
Sub-5 0.20*** 0.58*** 0.44*** 101
Notes: The table is based on primary data on 101 non-fnancial listed frms in Bangladesh; *, **,
and ***denote signifcance at 10, 5 and 1% levels, respectively; frms with the CGI of less than 34 are
placed in the repressive portfolio (denoted as REP), whilst the moderate portfolio (e.g. MOD) consists of
the frms with the CGI of greater than 48; row 4 shows the difference (t-statistics) in the means of frm
characteristics between the two portfolios
JFEP
7,3
242
D
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n
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a
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a
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a
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2
0
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6
(
P
T
)
Table IV.
The OLS regression
of equity fnance
against corporate
governance variables
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4
243
Corporate
governance
and equity
fnance
D
o
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P
O
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D
I
C
H
E
R
R
Y
U
N
I
V
E
R
S
I
T
Y
A
t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
the equity raised from the external sources. The F-statistics also imply a better
predictive power of the explanatory variables. To examine potential multi-collinearity,
Table Vshows the correlations amongst independent variables in the regression model.
The evidence suggests that multi-collinearity does not appear to have constrained the
infuence of the explanatory variables[10].
5. Analysis of the results
This section uses semi-structured interviews with various corporate stakeholders of
Bangladesh to analyse the empirical results and to identify their relevance to the
existing literature. The corporate fnancing pattern in emerging economies such as
Bangladesh tends to suffer most from the agency problems associated with controlling
shareholders’ expropriations. In addition to using their informational advantage to
expropriate minority shareholders’ rights (Shleifer and Vishny, 1997), the controlling
owners of most of the frms in Bangladesh become an integral part of management and,
thus, cause higher agency costs of equity, leading to lower equity funds from external
sources. They seem to capitalize the restrictive shareholder rights by exerting direct or
indirect infuence in the frm’s fnancing decisions in their own interests. This is mostly
profound in poorly governed frms, where the controlling shareholders choose readily
available bank debt in meeting the frm’s fnancing needs, whist retaining or increasing
their equity holdings to control the frm. Céspedes et al. (2010) also fnd that controlling
owners of Latin American frms prefer to use debt rather than equity because they do
not want to lose control rights. An increase in family control is likely to cause an increase
in expropriation practices by the controlling shareholders (Silva and Majluf, 2008),
leading to higher agency cost of equity. Consistent with this observation, the study
reveals that poor frm-level corporate governance (i.e. lower CGI) has a statistically
signifcant negative association with all measures of equity fnance.
Both direct and indirect interferences of the controlling shareholders in both fnancial
and non-fnancial frms appear to have inhibited the development of corporate culture in
relation to the independence and professionalism of executive management. The
interviews also reveal that the transparency and accountability in the corporate sector is
being constrained by manipulation in fnancial reporting, along with the opportunistic
behaviour of a group of external auditors. Whilst many frms have involvement in
Table V.
Correlation matrix
for the explanatory
variables
Categories 1 2 3 4 5 6 7 8
CGI 1
Concentration 0.44*** 1
Firm size 0.43*** 0.25*** 1
Proftability 0.33*** 0.31*** 0.04 1
Growth 0.19** 0.22*** 0.26*** 0.07 1
Tobin’s Q 0.43*** 0.40*** 0.04 0.29*** 0.25*** 1
Tangibility ?0.13* ?0.12 ?0.14* ?0.03 0.13* ?0.10 1
Age 0.28*** 0.29*** 0.12 0.02 ?0.04 0.16* ?0.34*** 1
Leverage 0.18** 0.10 0.36*** 0.02 0.02 ?0.09 ?0.0.07 0.16*
Notes: The correlation matrix is based on 98 non-fnancial listed frms; *, **, and ***denote
signifcance at 10, 5 and 1% levels, respectively
JFEP
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A
t
2
1
:
5
2
2
4
J
a
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a
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y
2
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1
6
(
P
T
)
different societal welfare programmes, such involvement is mainly derived from the
controlling shareholders’ intention to gain direct or indirect political and economic
benefts. Also, the controlling shareholders of the majority of listed frms tend to exploit
their political infuence and the weak regulatory structures to maximize private benefts
at the expense of the frm and outside shareholders.
This study fnds that the inadequacy and inconsistency in corporate laws, and the
absence of commitment, co-ordination and overlapping of powers and responsibilities of
the regulatory agencies, are major deterrents of corporate governance reform in
Bangladesh. Lack of investors’ awareness and initiatives to take legal action against the
errant frms has also played a part. This study further reveals that the market for
corporate control and the institutional investors’ activism is largely absent in the
corporate sector of Bangladesh. Whilst the broad-based fnancial reformmeasures have
brought about some improvements in the monitoring and surveillance activities of the
regulatory institutions (e.g. the Securities and Exchange Commission of Bangladesh),
the judicial stay order and political interference of groups of business people tend to
have constrained the regulatory activism.
In contrast to poor frm-level corporate governance inthe majorityof local frms, a group
of foreign and locally reputable frms not only comply with the existing out-of-date
regulatory provisions, but also voluntarily adopt better governance practices. The evidence
of positive association between the CGI and equity fnance implies that this difference in
frm-level corporate governance quality can explain the variations in the frm’s equity
fnancing pattern. Put differently, the evidence suggests a positive infuence of legal
compliance and/or voluntarily adoption of better governance practices. Better governance
quality appears to enhance investors’ confdence, which in turn helps frms gain increased
access to equity funds fromexternal sources.
Amongst the other determinants of equity fnance, proftability and age measures
tend to remain consistent and signifcant. Astatistically signifcant positive association
between proftability and equity fnance suggests that the investors prefer to invest
more in a proftable frmin the hope of higher future cash fows. Additionally, an inverse
relationship between age and equity fnance supports the observation of Ramano et al.
(2000) that a developing frm is more likely to rely on equity, primarily due to the
diffculty in getting access to debt fnance.
In summary, this study results confrmthe prediction of the agency theory in relation
to the positive infuence of frm-level corporate governance on the frm’s equity fnance.
This paper, therefore, makes an important contribution to the existing literature on
corporate governance and corporate fnance in the context of bank-based fnancial
systems in developing economies. This study also substantiates several studies (for
instance, La Porta et al., 1997; Claessens, 2003) with reference to the signifcance of better
frm-level governance to the frm’s access to equity fnance.
6. Conclusions
This study examines the relationship between frm-level corporate governance and
equity fnancing pattern of the non-fnancial listed frms in Bangladesh. Using a CGI, the
OLS regression framework appears to confrm the prediction of the agency theory in
relation to the infuence of governance quality on frm fnancing. The evidence of a
positive infuence of corporate governance quality on equity fnance supports the notion
that frms should improve their legal compliance and voluntary activism in corporate
245
Corporate
governance
and equity
fnance
D
o
w
n
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o
a
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e
d
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O
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I
C
H
E
R
R
Y
U
N
I
V
E
R
S
I
T
Y
A
t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
governance matters. The study results suggest that better corporate governance
enhances a frm’s access to equity fnance through reducing information asymmetry
between the controlling owners and external investors.
As mentioned earlier, controlling shareholders’ expropriation tends to restrain a
frm’s ability to gain access to equity capital in many emerging economies such as
Bangladesh. An overall improvement of frm-level corporate governance practices is
likely to reduce agency costs of controlling shareholders’ expropriation and improve
investors’ confdence. This eventually leads to several positive outcomes for a frmsuch
as, increased access to external capital (both debt and equity), lower cost of capital,
improved operating performance and higher valuation. This study contributes to the
literature by empirically looking at one of these linkages, e.g. frm-level corporate
governance and equity fnancing. Future empirical studies can examine or compare if
frm-level corporate governance quality has similar effects on other indicators of value
creation in the contexts of other emerging economies.
Notes
1. Shleifer andVishny(1997) argue that the presence of large investors (suchas, familyor banks)
might have a negative effect on equity fnance because of the possibility of expropriation of
minority shareholders’ rights, which prevents the latter from investing in the capital market.
2. See also, Dittmar and Thakor (2007).
3. These include, the equity contribution of the general investors or fnancial institutions
including the institutional investors who have invested through the primary and/or
secondary markets.
4. Among others, Klapper and Love (2004) argue that adding appropriate control variables can
be one way to mitigate the omitted variable problems.
5. It is not possible to use the simultaneous regression approach, primarily because of the
absence of time variation in the governance and fnancial data, along with the problem of
fnding appropriate instrumental variables.
6. Financial sector appears to dominate the market behaviour of the DSE, with nearly 52 per cent
(including banking frms with 47 per cent) of the total market capitalization and 53 per cent of
the total turnover (Estimated by the researcher based on the data on DSE Monthly Review,
December 2004, Vol. 19, No. 12).
7. Controlling shareholders include the controlling family and its relatives and close business
associates. For MNEs and government-controlled frms, sponsors are the parent companies
and government, respectively.
8. For this study, fnancial institutions include banks, insurance companies, leasing companies,
mutual funds and merchant banks.
9. Overall level of signifcance of CGI and other explanatory variables appear to be similar with
the highest or top ten concentration measures instead of top fve shareholding. All of these
concentration measures have the expected association with all equity fnancing proxies, but
none of them are statistically signifcant.
10. To examine the robustness of the explanatory power of CGI, the model is estimated without
frm size or Tobin’s Q or both (as these variables have relatively higher degree of correlation
with other variables). The regression results (not shown in the table) for CGI and other
variables tend to remain unchanged without proftability variable.
JFEP
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A
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2
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5
2
2
4
J
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y
2
0
1
6
(
P
T
)
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Appendix 1. Elements of corporate governance index (CGI)
Ownership pattern
• Does the majority shareholder (sponsor/family/government) group own less than 40 per
cent shares of the company?
• Do foreign investors/frm or local institutional investors (with the reputation for good
corporate governance) own at least 20 per cent shares?
Shareholder rights
• Do all equity holders have the right to call extra-ordinary general meeting (EGM)?
• Does the frm allow shareholders to vote via mail?
• Does the frm have representation of minority shareholders on the board?
• Does the frm normally take less than seven days to resolve the shareholders’ grievances?
• Has there been any controversy or questions during the past fve years over the decision of
the board or management in favour of majority shareholders/family or board/management
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at the expense of minority shareholders, e.g. whether any loan/benefts given to other
companies in the group or related parties (If there is no controversy, answer would be “1”).
• Whether the frm holds annual general meeting (AGM) on a regular basis?
Board and management issues
• Does the board have representative from institutional investors? (Foreign
institutions/sponsors and local institutions with good reputation CG are included but local
non-fnancial sponsors/conglomerates and banks/major creditors are excluded).
• Whether the board has any representative from banks or other major creditors? (Any
presence of Bank/Creditor nominee would be answered as “0”).
• Is there any foreigner(s) on the board?
• Does the board have less than/equal to one-third of the directors (less than or equal to two
for banks and less than or equal to four for insurance companies) from the same family/
relatives? (Answer “0” if more than two (three or more) for banks and fve or more for
insurance companies).
• Does the company have independent non-executive director(s)? *(Independent directors
should be appointed through the nomination of non- major/minority shareholders and
exclude executive directors, directors fromthe members of family of majority ownership or
other major shareholders).
• Are the positions of the Managing Director (MD) and board chairperson held by the
different individual?
• Whether the MDor one of the topthree executives is fromthe controllingfamily? (If fromthe
controlling family, answer would be “0”).
• Is there any provision of performance-based pay (e.g. salary, bonuses) for the executive
directors and other top-level executives?
• Do you have any system for evaluating the executive director’s performance?
• Does the frm hold at least four board meetings held per year?
• Do the directors attend at least 75 per cent of the board meetings on an average?
• Is there any provision to discipline or evaluate executive management (or has there been
any event of punishment or disciplinary action in the event of mismanagement?)
• Does the frm have an audit committee of the board?
• Do independent non-executive directors chair the audit committee?
• Is the ratio of non-executive directors in the audit committee 2/3 or more?
Disclosure to investors/transparency
• Does the frm have a strong internal audit department?
• Whether the audit committee or internal auditor report is presented to the
AGM/Bangladesh Bank (BB)/Securities and Exchange Commission (of Bangladesh) (SEC)?
• Does the frm have a well-organized investor relations/share department?
• Does the company have an explicit “mission statement” outlining the priority on good
corporate governance?
• Does the annual report of the company incorporate a section outlining the performance in
implementing corporate governance principles?
• Does the management disclose three-or fve-year key data on fnancial performance?
• Does the company publish annual reports within fve months of the end of the fnancial
year?
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• Does the company publish half-yearly reports within one month of the end of the half-year?
• In the annual report clear and informative? (Based on the researchers’ evaluation of the
annual report).
• Does the company have a website with updated fnancial results and announcements?
• Does the company disclose market-sensitive information consistently and punctually?
• Has the researcher had good access to the concerned person/senior management in terms of
promptness to respond, suffcient time and detailed information without misleading?
(Based on researchers’ personal experience during the feld survey).
Responsibility towards the stakeholders
• Does the frm provide suffcient employee training programme?
• Does the frm contribute to different community development or social welfare
programmes?
• Has there been any initiative taken to protect the environment from pollution?
• Does the frm provide satisfactory employee welfare programme (e.g. retirement beneft
housing scheme, transportation, schooling/scholarship of employee’s children)?
• Is that true that the frmcontribute to the welfare programme for the disabled/handicapped
people?
• Has there been any initiative to promote education?
Corresponding author
Faizul Haque can be contacted at: [email protected]
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doc_971124932.pdf
This paper aims to investigate whether firm-level corporate governance has an influence on
the equity financing patterns in an emerging economy such as Bangladesh
Journal of Financial Economic Policy
Corporate governance and equity finance: an emerging economy perspective
Faizul Haque
Article information:
To cite this document:
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perspective", J ournal of Financial Economic Policy, Vol. 7 Iss 3 pp. 233 - 250
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Corporate governance and equity
fnance: an emerging economy
perspective
Faizul Haque
Department of Accountancy, Economics and Finance,
Heriot-Watt University Dubai Campus, Dubai International Academic City,
Dubai, UAE
Abstract
Purpose – This paper aims to investigate whether frm-level corporate governance has an infuence on
the equity fnancing patterns in an emerging economy such as Bangladesh.
Design/methodology/approach – The regression framework uses a questionnaire survey-based
corporate governance index (CGI) comprising fve dimensions – ownership structures, shareholder
rights, independence and responsibilities of the board and management, fnancial reporting and
disclosures and responsibility towards stakeholders. In addition, a number of semi-structured
interviews have been carried out with the relevant stakeholders.
Findings – The results suggest a statistically signifcant positive relationship between CGI and equity
capital and, thus, confrm the prediction of the agency theory.
Research limitations/implications – This study does not address endogeneity and reverse
causality issues with respect to the relationship between CGI and equity fnance.
Practical implications – Firms should improve their legal compliance and voluntary activism in
corporate governance matters to ensure increased access to equity fnance.
Originality/value – This study is among the frst to examine the relationship between overall
corporate governance quality and equity fnance of a frm from the perspective of a bank-based
emerging economy.
Keywords Bangladesh, Agency theory, Corporate fnance and governance, Equity fnance
Paper type Research paper
1. Introduction
A frm’s ability to persuade investors about the frm’s governance quality appears to
infuence the equity fnancing of a frm. Better corporate governance and associated
stronger shareholder rights reduce agency costs (Gompers et al., 2003), which in turn
enhance a frm’s ability to gain access to equity fnance. While many studies (Haque
et al., 2011; Drobetz et al., 2004) investigate the infuence of corporate governance on debt
fnance or on cost of equity capital, the literature on the empirical relationship between
frm-specifc corporate governance and frm’s equity fnance appears to be limited.
JEL classifcation – G32, G34, G38, O16
The author gratefully acknowledges the helpful comments fromthe anonymous reviewers and
the editors. An initial version of this paper was presented at an International Conference on
Corporate Governance at BirminghamBusiness School in 2006. The author thanks the conference
participants, Colin Kirkparick and Thankom Arun for their valuable comments.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
Corporate
governance
and equity
fnance
233
Received23 November 2014
Revised3 February2015
3 March2015
Accepted12 March2015
Journal of Financial Economic
Policy
Vol. 7 No. 3, 2015
pp. 233-250
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-11-2014-0070
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Several studies (Céspedes et al., 2010; Patibandla, 2006) consider individual governance
issues such as ownership or management structures, rather than overall frm-level
governance practices. No study to date focuses on the linkage between corporate
governance and equity fnancing in Bangladesh.
This study contributes to the existing agency theory-based literature on the
relationship between corporate governance and equity fnance from the perspective of
an emerging economy such as Bangladesh, where the capital market and the corporate
sectors are very weak, and the fnancial system is predominantly bank-based.
Bangladesh represents an interesting case for this study because the country’s fnancial
sector has been experiencing reform initiatives since 2001. However, little is known
about the effect of fnancial sector reform on capital market development in terms of
relatively better corporate governance practices and better investors’ confdence. This
study is likely to have important policy implications in relation to the impact of fnancial
sector reform that was undertaken to strengthen the capacity building of the capital
market. This paper investigates the infuence of frm-level governance quality on equity
fnance of 101 non-fnancial listed frms in Bangladesh.
Another important motivation of this study is to measure overall corporate governance
practices of afrmrather thanthe individual governance component. This is because several
inter-related factors including the ownership pattern, independence and responsibilities of
the board and management, transparency and accountability and responsibility towards
stakeholders tend to infuence frm-level corporate governance. This study uses ordinary
least square (OLS) regression to examine the effect of a frm’s overall governance quality
measuredthroughacorporategovernanceindex(CGI). Thefndingsof thestudysupport the
prediction of the agency theory, with a statistically signifcant positive association between
frm-level corporate governance and the frm’s equity fnance.
The organization of the paper is as follows: Section 2 reviews the available literature
and Section 3 presents the research question and empirical model. Section 4 presents the
empirical analysis, including the data, the patterns capital structure and ownership, the
univariate analysis and the regression results. Section 5 analyses the study results and
Section 6 concludes this paper.
2. Literature review
The literature on the fnance-related aspect of corporate governance is primarily based
on the agency theory. While Jensen and Meckling (1976) refer to two types of agency
conficts in a frm(i.e. between the shareholders and managers, and the shareholders and
creditors), Shleifer and Vishny (1997) suggest that a confict of interests can occur
between large controlling block holders and minority shareholders. This is particularly
relevant to the Asian developing economies, where large controlling shareholders can
cause enormous agency problems through direct or indirect expropriation of minority
shareholder rights. Céspedes et al. (2010) also observe that in Latin America, asymmetric
information problem exists between large shareholders and the rest of fnancing
providers (i.e. small shareholders and debtholders). This eventually results in poor
governance quality of a frm.
However, empirical literature on the relationship between frm-level corporate
governance and the frm’s equity fnancing pattern tends to be limited. Among others,
La Porta, Lopez-de-Silanes, Shleifer and Vishny, henceforth La Porta et al. (1997) and
Claessens (2003) address the signifcance of frm- (and/or country) level governance to
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the investors’ improved confdence and the frm’s increased access to equity fnance.
Gugler et al. (2003) and Gilson (2000) also mention that good governance practices
infuence higher-equity investment, regardless of a country’s legal institutions. Shleifer
and Vishny (1997) argue that a frm is likely to get external fnance not only because of
the reputation of the capital market and excessive investor optimism, but also due to
positive assurances provided by the corporate governance system. Investors are likely
to provide more fnance if they are given greater assurance (through better governance)
of a fair return on their investment.
Alternatively, as Shleifer and Vishny (1997) mention[1], the controlling shareholders’
expropriation of minority shareholder rights can cause higher agency cost of equity,
leading to lower equity funds from external sources. Likewise, controlling owners of
poorly governed frms are likely to prefer readily available bank debt to meet the frm’s
fnancing needs, whilst retaining absolute ownership and control over the frm.
Apart from corporate governance, several other frm-specifc factors such as frm
size, age, proftability, growth, asset tangibility and debt ratio tend to infuence a frm’s
equity fnancing pattern. Rajan and Zingales (1995) and Kumar (2005) argue that lower
informationasymmetryproblems betweenthe insiders andoutside shareholders of the large
frms exert a positive infuence on equity fnance, due to lower agency cost of equity.
However, Dittmar and Thakor (2007) argue that larger frms enjoy lower cost of debt and
may prefer debt to equity for this reason. Schäfer et al. (2004) regard that the age of the frm
is animportant determinant of the frms’ equityfnancingpattern, andargue that the degree
of asymmetric information is extremely high between the investor and a frm in its early
stage of development. Nonetheless, Ramano et al. (2000) argue that developing (i.e. younger)
frms tend to rely on equity, due to their diffculty in raising debt.
Proftability tends to be inversely associated with the equity fnancing pattern, as
Dittmar and Thakor (2007) assert that highly proftable frms generate high retained
earnings and use this to fnance projects internally. This is because perceived confict of
interests between the insiders and outside investors infuences a frm to select retained
earnings over external fnancing (Suto, 2003). Moreover, the asymmetric information
problems and associated high cost of raising equity makes equity as the least favoured
fnancing option (Du and Dai, 2005). However, proftability can be positively associated
with equity fnance, as the outside investors might be inclined to invest more in
proftable frms in the hope of higher future return on equity. Likewise, Lombardo and
Pagano (2002) argue that proftability increases the marginal productivity of capital that
causes an outward shift in the proftability schedule, leading to an increased demand for
equity capital.
Myers (1977) and Rozeff (1982) regard growth opportunity as an important
determinant of capital structure decisions. Firms with higher growth opportunities are
more likely to rely on equity fnance[2] due to the potential bankruptcy or fnancial
distress risks associated with corporate leverage (Du and Dai, 2005). Nonetheless, the
controlling shareholders’ intention to retain ownership and control right is likely to
drive growing frms to rely more on debt rather than equity. This is especially noticeable
in the bank-based fnancial systems in emerging countries, where obtaining both long
and short-term bank loans is relatively easier.
Dittmar and Thakor (2007) argue that asset tangibility is an important determinant of a
frm’s choice of equity (versus debt). Asset tangibility is presumed to have a negative
association with equity fnance, as Rajan and Zingales (1995) suggest, frms with more
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tangible assets are more likelyto use debt fnance. This is because the relative importance of
collateral value in the equity contract is likely to be lower than that of a debt contract. The
debt ratio can also be an important determinant of a frm’s equity fnancing pattern, as
Dittmar and Thakor (2007) refer to the trade-off theory which suggests that an overvalued
frmis more reliant onequityover debt. However, a frm’s higher access (or reliance) ondebt
fnance may cause a negative infuence on equity fnance.
3. Hypothesis and model
This paper is based on the prediction of the agency theory in relation to the infuence of
corporate governance on equity fnance. The agency problems associated with the
confict of interests in family controlled frms is particularly relevant to the corporate
governance setting of a developing economy, where controlling family or shareholders
cause enormous agency costs through various forms of expropriation of external
shareholder rights. This paper addresses the following hypothesis:
H1. Corporate governance quality is positively associated with the frm’s equity
fnancing pattern.
In the absence of adequate literature on corporate governance and the frm’s equity
fnance, it is rather diffcult to identify a dependent variable to denote the proportion of
equity in a frm’s capital structure. This study follows Wu et al. (2007) in using the ratio
of shareholders’ equity (i.e. book value of equity capital) to total assets as an equity
fnancing measure. However, the inclusion of retained earnings in the shareholders’
equity is likely to undermine the suitability of this variable. This problem can partly be
resolved by taking the ratio of market value of equity (i.e. market capitalization) to total
assets as a proxy for the frm’s equity fnance.
Nonetheless, as La Porta et al. (1997) argue, taking total market capitalization of a
frm with signifcant family shareholding is likely to overestimate the proportion of
equity raised from external sources. Following La Porta, Lopez-de-Silanes, Shleifer and
Vishny (LLSV), this study uses the ratio of market capitalization held by outsiders to the
frm’s cash fow (identifed as equity-to-cash) as one of the frm-level equity variables.
The amount of market value of equity owned by the outside shareholders is the total
market capitalization multiplied by the proportion of equity held by non-controlling
shareholders[3]. The cash fowis the sumof the non-cash charges (e.g. depreciation and
amortization) and the net income after taxes. In addition, this study uses both the book
value of equity to total assets (indicated by book-to-assets), and the market value of
equity to total assets (denoted as market-to-assets) to investigate whether the infuence
of corporate governance remains consistent across different equity measures.
Taking these alternative equity fnancing measures as dependent variables, this
study develops the following regression model:
Equity Finance (?) ?
? ? ?
1
(CGI) ? ?
2
(Concentration) ? ?
3
(Size)
??
4
(Profitability) ? ?
5
(Historical growth)
??
6
(Growth potential) ? ?
7
(Tangibility) ? ?
8
(Age)
??
9
(Debt ratio) ? ?
10
(Industry dummies) ? ?
(1)
This cross-sectional model incorporates frm-level CGI as the main test variable, with
higher CGI specifying better governance quality of the frm. Better corporate
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governance tends to infuence a frm’s capital structure decisions towards equity
fnance. The model also includes ownership concentration (i.e. percentage of top fve
shareholdings) as an additional governance variable. As mentioned above, the large (or
concentrated) shareholding is likely to have an inverse effect on equity fnance.
Based on the review of literature on the determinants of equity fnance, the
regression framework also includes several frmcharacteristics as control variables.
These include, frm size (measured as the natural logarithm of assets), proftability
or return on assets (the ratio of net income after taxes to total assets), historical
growth (average asset growth rate over a period of past three or fve years), growth
potential (Tobin’s Q), asset tangibility (the ratio of fxed assets-to-total assets), age
(number of years as a listed frm), debt ratio (long term debt-to-total assets) and the
industry dummies based on four digit Standard Industrial Classifcation (SIC) codes.
Agrowing body of literature puts forward the issue of endogeneity with reference to
the association between corporate governance and fnancial performance. Among
others, Gompers et al. (2003) mention that the difference in fnancial performance
amongst frms might be driven not only from the governance provisions, but also from
other unobservable or diffcult-to-measure frm characteristics associated with the
governance quality. Himmbelberg et al. (1999) observe that a large fraction of the
cross-sectional variation in managerial ownership is explained by unobserved frm
heterogeneity or fxed-frm effect. Whilst the study does not address this issue, the OLS
regression framework is intended to mitigate the omitted variable problem by
incorporating several frm-specifc characteristics and industry dummies as control
variables[4].
Among others, Demsetz and Villalonga (2001) refer to reverse (or two-way) causality
as another important frm-level endogeneity issue. For instance, Klapper and Love
(2004) mention that frms with greater need for external fnance are more inclined to
adopt better governance practices (to ensure low cost of capital), rather than vice-versa.
The present single equation model does not address this causality issue[5]. This remains
to be a caveat of the study with respect to the causal relation between corporate
governance quality and equity fnance.
4. Empirical analysis
This section explains the data including the CGI, followed by the ownership structures
and equity fnancing pattern, the univariate analysis and the regression results.
4.1 The data
This cross-sectional study is based on the survey data on corporate governance and the
published data on equity fnancing pattern in Bangladesh. Amongst the 186
non-fnancial listed frms of the prime exchange of the country known as the Dhaka
Stock Exchange (DSE), 101 frms responded to the survey (carried out by the author in
2004), with the response rate being approximately 55 per cent. The respondents of the
questionnaire were the CEOs, company secretaries, executive board members, fnance
directors, chief accountants or other senior executives depending on the availability and
accessibility. The sample frms capture nearly 96 per cent of the total market capitalization
(MC) of all non-fnancial frms, and 45 per cent MCof the DSE[6]. The data on equity fnance
and other frm characteristics are collected from the annual reports of the sample frms for
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the latest fnancial year (2004-2005) and the DSE monthly reviews. In addition, fve
semi-structured interviews have been carried out with the relevant stakeholders.
Given the widely established concern about the reliability of the data, especially in
the context of a developing country such as Bangladesh, the CGI is based on a
questionnaire survey in an effort to improve the level of accuracy of the governance
data. Inaddition, the fnancial dataare basedonthe companyandDSEpublications. Whilst
this remains amethodological weakness, it appears that there is noother optionbut toaccept
the publiclyavailable datathat are basedonanoutdateddisclosure framework. As Ethridge
(2004, p. 151) argues, “We effectively assume that secondary (i.e. published) data are
error-free because we have no defense for using it if we do not make that assumption”.
Another potential drawback of the study is the usage of cross-sectional data in empirical
estimation. Given the diffculty in getting access to data in an emerging economy like
Bangladesh, questionnaire survey appears to be the only alternative to collect frm-specifc
governance data. However, it is not possible to conduct another survey (to construct a panel
dataset) due to the time and fnancial constraints.
4.1.1 Corporate governance index. To quantify the governance-related issues, this
study constructs a CGI, consisting of fve individual governance components, namely,
the ownership pattern (sub-index 1), shareholder rights (sub-index 2), independence and
responsibilities of the board and management (sub-index 3), fnancial reporting and
disclosures (sub-index 4) and responsibility towards stakeholders (sub-index 5). This
study follows, among others, Black et al. (2006) and Klapper and Love (2004) in selecting
the individual elements of CGI, although several elements are modifed to make the
index compatible with the legal and regulatory issues in Bangladesh. The frm-specifc
scoring of the corporate governance practices in Bangladesh might not be comparable to
international governance ratings. Given the drawbacks of weak legal and regulatory
structure of the country, this study is intended to measure (and rank) the frm’s relative
voluntary activism and/or legal compliance in corporate governance matters.
The CGI and its sub-indices incorporate a total of 41 dichotomous variables (attached
in the appendix). Each variable in the sub-indices had a value 1 or 0, with 1 being the
compliance with better corporate governance practices or 0 otherwise. A sub-index is
the sum of the values of all variables within that index, divided by the number of
non-missing variables. Afterwards, the ratio is multiplied by 20 to facilitate comparison
of the sample frms and to assign equal weight to each sub-index (see also Black et al.,
2006). This has led to the value of the resulting sub-index between 0 and 20. Finally, the
CGI is the sum of the values of all fve sub-indices. The CGI of each sample frm carries
a value between 0 and 100, with the higher score denoting a frm’s better governance
quality. The study assigns equal weight to all of the fve sub-indices, as there is no
established theoretical model of assigning different weights to different sub-indices or
equal weight to each of the variables within the sub-indices.
One potential methodological concern is the validity of CGI as a measure of corporate
governance quality of a frm. This study uses Cronbach’s alpha to test the ability of the
instrument (e.g. CGI) to measure what is it is supposed to measure (see Saunders et al.,
2009). The Cronbach’s alpha of all fve sub-indices of CGI is 0.806, which indicates a high
level of internal consistency (e.g. internal validity) of individual corporate governance
issues that constitute the CGI. Moreover, as mentioned above, this study follows, among
others, two of the widely cited papers (Black et al., 2006; Klapper and Love, 2004) in
selecting the individual elements of CGI. This is likely to address concerns on content
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validity, e.g. whether the elements of CGI provide adequate coverage of the quality of
corporate governance of a frm. It is important to mention that CGI data are based on a
structured questionnaire survey administered by the author through face-to-face
interactions with the respondents. The author spent six months in Bangladesh to
conduct this survey as part of the author’s doctoral research programme fromone of the
top Russell group Universities in the UK. The author complied with all required policies
of that University in relation to research ethics for PhD students.
The distribution of CGI of 101 non-fnancial frms reveals that the mean (median)
value of the CGI is 40.84 (41.67), whilst the standard deviation is 21.23. The standard
deviation implies a higher degree of dispersion between the governance scores of many
listed frms and the average governance index. One of the reasons of this distribution is
the widespread difference in governance qualities among the sample frms in various
categories (e.g. foreign versus local).
Table I shows the mean distribution of CGI and fve sub-indices across various
industrial categories. The table shows that the quality of corporate governance amongst
the foreign frms is very high in relation to the locally controlled frms. This is because
the former seems to follow internationally recognized best practices in many aspects of
governance. The presence of foreign frms has also caused higher scores in several
sectors such as electrical equipments, leather, chemical and tobacco.
4.2 Existing ownership structure and external equity fnancing
Table II shows the capital structure and shareholding patterns of non-fnancial listed
frms in Bangladesh. Panel-1 of the table shows that debt fnancing dominates the frm’s
fnancing pattern, with the proportion of debt in the total assets being around 69 per
cent. The controlling shareholders[7] provide roughly 16 per cent of the total assets
as equity funds, whilst external shareholders (e.g. fnancial institutions and
minority shareholders) contribute the remaining 15 per cent. The table also shows
that long-termdebt constitutes one-ffth of the total assets. Altogether, non-fnancial
frms in Bangladesh tend to have a high degree of reliance on short-term bank debt
instead of equity or long-term debt. Given the poor state of default culture in the
banking sector of Bangladesh, this study result does not seem to be surprising
because it is easier for the frms to get bank loans without facing any stringent
punishment for being defaulted.
Panel-2 shows that the largest shareholder owns around 31 per cent equity in the
sample frms. The average ownership stakes of the top fve and top ten shareholders
are 57 and 65 per cent, respectively. This pattern of shareholding portrays a highly
concentrated pattern of ownership in the corporate sector of Bangladesh. Overall,
foreign frms show much more concentrated shareholding (generally by the parent
company) than their local counterparts in all concentration measures.
Panel-3 of the table shows that the founding family and its associates (with whomthe
former has personal, business or political affliations) exert direct control over the frm
by owning around 36 per cent of the shares. The table also depicts that the fnancial
institutions[8] and minority (or dispersed) shareholders own around 20 and 30 per cent
stakes, respectively. Financial Institutions and general shareholders tend to acquire
shares through primary and/or secondary equity markets. The table further
demonstrates that the government owns around 5 per cent shares in the sample frms,
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Table I.
Mean values
corporate governance
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industries
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although several listed frms are signifcantly state-owned. While some of the country’s
well-governed listed frms are owned mainly by foreign corporations, the average level
of foreign shareholding is roughly 9 per cent.
4.3 Univariate analysis
Table III presents the t-test and correlation matrix for corporate governance and equity
fnancing measures. Following Gompers et al. (2003), this study uses governance scores
to construct two extreme portfolios such as the repressive portfolio (i.e. frms with poor
governance quality, with CGI ?34) and moderate portfolio (i.e. better governed frms,
with CGI ?48). Both portfolios represent the upper (33 frms) and lower (33 frms) third
of the sample. Panel-1 of Table III shows that better-governed (i.e. moderate portfolio)
frms have relatively higher level of equity fnance than the frms in the repressive
portfolio. The table also shows that the differences in book-to-assets, market-to-assets
and equity-to-cash between these two portfolios are statistically signifcant.
Panel-2 of the table shows that the three proxy measures of equity fnance (columns
1 through 3) are positively related with the CGI and its sub-indices. Interestingly,
positive correlations between equity-to-cash and fve governance indices suggest that
good-governed frms tend to have higher level of equity from the external sources. The
univariate analysis, thus, suggests that corporate governance quality does have an
infuence on the frm’s equity fnancing pattern.
Table II.
Sector-wise
distribution of capital
structure, ownership
concentration and
types of ownership
Capital structure and
ownership
Manufacturing
(%)
Non-fnance
service (%)
Foreign
(%)
Local
(%)
Total
(%)
Panel-1: capital structure
i. Total debt 71.50 39.24 47.75 71.28 68.95
Long-term debt 21.50 8.76 9.14 21.55 20.32
Short-term debt 50.00 30.48 38.61 49.73 48.63
ii. Shareholders’ equity 28.50 60.76 52.25 28.72 31.05
Sponsors’ funds 14.22 32.30 36.97 13.76 15.57
External equity 14.28 28.46 15.28 14.96 15.48
Total (i ?ii) 100 100 100 100 100
Panel-2: ownership concentration
i. Largest 31.50 28.30 62.60 27.80 31.20
ii. Top 5 57.00 51.80 82.90 53.70 56.60
iii. Top 10 65.40 63.10 86.20 62.90 65.20
Panel-3: types of ownership
i. Controlling Owners 34.79 46.91 3.59 39.27 35.74
ii. Financial Institution 20.69 11.88 15.52 20.48 20.00
iii. Public(dispersed) 29.40 34.96 13.72 31.62 29.84
iv. Government 5.58 – 0.44 5.66 5.14
v. Foreign 9.54 6.25 66.73 2.97 9.28
Total (i through v) 100 100 100 100 100
Sample Size 93 8 10 91 101
Source: Questionnaire survey data
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4.4 Regression results
Table IV presents the OLS regression results of the relationship between corporate
governance and three alternative measures of equity fnance, namely, equity-to-cash,
book-to-assets and market-to-assets. Column 1 shows that the main treatment variable
(e.g. CGI) enters with a statistically signifcant positive coeffcient in the regression of
equity-to-cash. In addition, age, frm size and debt ratio have statistically signifcant
negative coeffcients. After controlling for industry dummies in Column 2, the
regression results remain unchanged, with an exception to debt ratio that turns out to be
insignifcant. Also, proftability turns into a statistically signifcant positive coeffcient.
Column 3 presents regression results with ownership concentration as an additional
governance variable. The regression coeffcients for the CGI and other explanatory
variables remain unaltered[9], although the debt ratio turns out to be signifcant. The
estimation of the same specifcation with the industry dummies in Column 4 brings
almost identical results, with the debt ratio turning out to be insignifcant.
Column 5 presents similar specifcation results with book-to-assets as the dependent
variable. The estimation results show that the CGI, being the only governance variable,
maintains a statistically signifcant positive sign. Amongst the control variables,
proftability and age maintain statistically signifcant positive and negative signs,
respectively. The inclusion of ownership concentration as an additional governance
variable in Column 6 does not change the regression signs, with the new governance
variable remaining negative and insignifcant. Columns 7 and 8 of Table IV show
identical specifcation results (with and without the concentration measure), with
market-to-assets as the dependent variable. However, growth potential and debt ratio
turn out to be statistically signifcant.
Overall, the adjusted R
2
values of all alternative specifcations suggest that the model
has a better explanatory power in estimating the variability in equity fnance, including
Table III.
T-test and
correlation matrix for
corporate governance
and equity fnancing
measures
Equity variables
Book-to-assets Market-to-assets Equity-to-cash n
1 2 3 4
Panel-1: mean ratios
All 0.31 0.66 2.89 101
Moderate 0.50 1.28 4.08 33
Repressive ?0.03 0.19 1.42 33
Difference (t-statistics) 0.54*** 1.09*** 2.66*
Panel-2: correlation with CGI and sub-indices
CGI 0.30*** 0.69*** 0.44*** 101
Sub-1 0.21** 0.21** 0.08 101
Sub-2 0.23*** 0.68*** 0.42*** 101
Sub-3 0.08 0.50*** 0.25*** 101
Sub-4 0.28*** 0.64*** 0.43*** 101
Sub-5 0.20*** 0.58*** 0.44*** 101
Notes: The table is based on primary data on 101 non-fnancial listed frms in Bangladesh; *, **,
and ***denote signifcance at 10, 5 and 1% levels, respectively; frms with the CGI of less than 34 are
placed in the repressive portfolio (denoted as REP), whilst the moderate portfolio (e.g. MOD) consists of
the frms with the CGI of greater than 48; row 4 shows the difference (t-statistics) in the means of frm
characteristics between the two portfolios
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Table IV.
The OLS regression
of equity fnance
against corporate
governance variables
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T
a
b
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4
243
Corporate
governance
and equity
fnance
D
o
w
n
l
o
a
d
e
d
b
y
P
O
N
D
I
C
H
E
R
R
Y
U
N
I
V
E
R
S
I
T
Y
A
t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
the equity raised from the external sources. The F-statistics also imply a better
predictive power of the explanatory variables. To examine potential multi-collinearity,
Table Vshows the correlations amongst independent variables in the regression model.
The evidence suggests that multi-collinearity does not appear to have constrained the
infuence of the explanatory variables[10].
5. Analysis of the results
This section uses semi-structured interviews with various corporate stakeholders of
Bangladesh to analyse the empirical results and to identify their relevance to the
existing literature. The corporate fnancing pattern in emerging economies such as
Bangladesh tends to suffer most from the agency problems associated with controlling
shareholders’ expropriations. In addition to using their informational advantage to
expropriate minority shareholders’ rights (Shleifer and Vishny, 1997), the controlling
owners of most of the frms in Bangladesh become an integral part of management and,
thus, cause higher agency costs of equity, leading to lower equity funds from external
sources. They seem to capitalize the restrictive shareholder rights by exerting direct or
indirect infuence in the frm’s fnancing decisions in their own interests. This is mostly
profound in poorly governed frms, where the controlling shareholders choose readily
available bank debt in meeting the frm’s fnancing needs, whist retaining or increasing
their equity holdings to control the frm. Céspedes et al. (2010) also fnd that controlling
owners of Latin American frms prefer to use debt rather than equity because they do
not want to lose control rights. An increase in family control is likely to cause an increase
in expropriation practices by the controlling shareholders (Silva and Majluf, 2008),
leading to higher agency cost of equity. Consistent with this observation, the study
reveals that poor frm-level corporate governance (i.e. lower CGI) has a statistically
signifcant negative association with all measures of equity fnance.
Both direct and indirect interferences of the controlling shareholders in both fnancial
and non-fnancial frms appear to have inhibited the development of corporate culture in
relation to the independence and professionalism of executive management. The
interviews also reveal that the transparency and accountability in the corporate sector is
being constrained by manipulation in fnancial reporting, along with the opportunistic
behaviour of a group of external auditors. Whilst many frms have involvement in
Table V.
Correlation matrix
for the explanatory
variables
Categories 1 2 3 4 5 6 7 8
CGI 1
Concentration 0.44*** 1
Firm size 0.43*** 0.25*** 1
Proftability 0.33*** 0.31*** 0.04 1
Growth 0.19** 0.22*** 0.26*** 0.07 1
Tobin’s Q 0.43*** 0.40*** 0.04 0.29*** 0.25*** 1
Tangibility ?0.13* ?0.12 ?0.14* ?0.03 0.13* ?0.10 1
Age 0.28*** 0.29*** 0.12 0.02 ?0.04 0.16* ?0.34*** 1
Leverage 0.18** 0.10 0.36*** 0.02 0.02 ?0.09 ?0.0.07 0.16*
Notes: The correlation matrix is based on 98 non-fnancial listed frms; *, **, and ***denote
signifcance at 10, 5 and 1% levels, respectively
JFEP
7,3
244
D
o
w
n
l
o
a
d
e
d
b
y
P
O
N
D
I
C
H
E
R
R
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t
2
1
:
5
2
2
4
J
a
n
u
a
r
y
2
0
1
6
(
P
T
)
different societal welfare programmes, such involvement is mainly derived from the
controlling shareholders’ intention to gain direct or indirect political and economic
benefts. Also, the controlling shareholders of the majority of listed frms tend to exploit
their political infuence and the weak regulatory structures to maximize private benefts
at the expense of the frm and outside shareholders.
This study fnds that the inadequacy and inconsistency in corporate laws, and the
absence of commitment, co-ordination and overlapping of powers and responsibilities of
the regulatory agencies, are major deterrents of corporate governance reform in
Bangladesh. Lack of investors’ awareness and initiatives to take legal action against the
errant frms has also played a part. This study further reveals that the market for
corporate control and the institutional investors’ activism is largely absent in the
corporate sector of Bangladesh. Whilst the broad-based fnancial reformmeasures have
brought about some improvements in the monitoring and surveillance activities of the
regulatory institutions (e.g. the Securities and Exchange Commission of Bangladesh),
the judicial stay order and political interference of groups of business people tend to
have constrained the regulatory activism.
In contrast to poor frm-level corporate governance inthe majorityof local frms, a group
of foreign and locally reputable frms not only comply with the existing out-of-date
regulatory provisions, but also voluntarily adopt better governance practices. The evidence
of positive association between the CGI and equity fnance implies that this difference in
frm-level corporate governance quality can explain the variations in the frm’s equity
fnancing pattern. Put differently, the evidence suggests a positive infuence of legal
compliance and/or voluntarily adoption of better governance practices. Better governance
quality appears to enhance investors’ confdence, which in turn helps frms gain increased
access to equity funds fromexternal sources.
Amongst the other determinants of equity fnance, proftability and age measures
tend to remain consistent and signifcant. Astatistically signifcant positive association
between proftability and equity fnance suggests that the investors prefer to invest
more in a proftable frmin the hope of higher future cash fows. Additionally, an inverse
relationship between age and equity fnance supports the observation of Ramano et al.
(2000) that a developing frm is more likely to rely on equity, primarily due to the
diffculty in getting access to debt fnance.
In summary, this study results confrmthe prediction of the agency theory in relation
to the positive infuence of frm-level corporate governance on the frm’s equity fnance.
This paper, therefore, makes an important contribution to the existing literature on
corporate governance and corporate fnance in the context of bank-based fnancial
systems in developing economies. This study also substantiates several studies (for
instance, La Porta et al., 1997; Claessens, 2003) with reference to the signifcance of better
frm-level governance to the frm’s access to equity fnance.
6. Conclusions
This study examines the relationship between frm-level corporate governance and
equity fnancing pattern of the non-fnancial listed frms in Bangladesh. Using a CGI, the
OLS regression framework appears to confrm the prediction of the agency theory in
relation to the infuence of governance quality on frm fnancing. The evidence of a
positive infuence of corporate governance quality on equity fnance supports the notion
that frms should improve their legal compliance and voluntary activism in corporate
245
Corporate
governance
and equity
fnance
D
o
w
n
l
o
a
d
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governance matters. The study results suggest that better corporate governance
enhances a frm’s access to equity fnance through reducing information asymmetry
between the controlling owners and external investors.
As mentioned earlier, controlling shareholders’ expropriation tends to restrain a
frm’s ability to gain access to equity capital in many emerging economies such as
Bangladesh. An overall improvement of frm-level corporate governance practices is
likely to reduce agency costs of controlling shareholders’ expropriation and improve
investors’ confdence. This eventually leads to several positive outcomes for a frmsuch
as, increased access to external capital (both debt and equity), lower cost of capital,
improved operating performance and higher valuation. This study contributes to the
literature by empirically looking at one of these linkages, e.g. frm-level corporate
governance and equity fnancing. Future empirical studies can examine or compare if
frm-level corporate governance quality has similar effects on other indicators of value
creation in the contexts of other emerging economies.
Notes
1. Shleifer andVishny(1997) argue that the presence of large investors (suchas, familyor banks)
might have a negative effect on equity fnance because of the possibility of expropriation of
minority shareholders’ rights, which prevents the latter from investing in the capital market.
2. See also, Dittmar and Thakor (2007).
3. These include, the equity contribution of the general investors or fnancial institutions
including the institutional investors who have invested through the primary and/or
secondary markets.
4. Among others, Klapper and Love (2004) argue that adding appropriate control variables can
be one way to mitigate the omitted variable problems.
5. It is not possible to use the simultaneous regression approach, primarily because of the
absence of time variation in the governance and fnancial data, along with the problem of
fnding appropriate instrumental variables.
6. Financial sector appears to dominate the market behaviour of the DSE, with nearly 52 per cent
(including banking frms with 47 per cent) of the total market capitalization and 53 per cent of
the total turnover (Estimated by the researcher based on the data on DSE Monthly Review,
December 2004, Vol. 19, No. 12).
7. Controlling shareholders include the controlling family and its relatives and close business
associates. For MNEs and government-controlled frms, sponsors are the parent companies
and government, respectively.
8. For this study, fnancial institutions include banks, insurance companies, leasing companies,
mutual funds and merchant banks.
9. Overall level of signifcance of CGI and other explanatory variables appear to be similar with
the highest or top ten concentration measures instead of top fve shareholding. All of these
concentration measures have the expected association with all equity fnancing proxies, but
none of them are statistically signifcant.
10. To examine the robustness of the explanatory power of CGI, the model is estimated without
frm size or Tobin’s Q or both (as these variables have relatively higher degree of correlation
with other variables). The regression results (not shown in the table) for CGI and other
variables tend to remain unchanged without proftability variable.
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Appendix 1. Elements of corporate governance index (CGI)
Ownership pattern
• Does the majority shareholder (sponsor/family/government) group own less than 40 per
cent shares of the company?
• Do foreign investors/frm or local institutional investors (with the reputation for good
corporate governance) own at least 20 per cent shares?
Shareholder rights
• Do all equity holders have the right to call extra-ordinary general meeting (EGM)?
• Does the frm allow shareholders to vote via mail?
• Does the frm have representation of minority shareholders on the board?
• Does the frm normally take less than seven days to resolve the shareholders’ grievances?
• Has there been any controversy or questions during the past fve years over the decision of
the board or management in favour of majority shareholders/family or board/management
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at the expense of minority shareholders, e.g. whether any loan/benefts given to other
companies in the group or related parties (If there is no controversy, answer would be “1”).
• Whether the frm holds annual general meeting (AGM) on a regular basis?
Board and management issues
• Does the board have representative from institutional investors? (Foreign
institutions/sponsors and local institutions with good reputation CG are included but local
non-fnancial sponsors/conglomerates and banks/major creditors are excluded).
• Whether the board has any representative from banks or other major creditors? (Any
presence of Bank/Creditor nominee would be answered as “0”).
• Is there any foreigner(s) on the board?
• Does the board have less than/equal to one-third of the directors (less than or equal to two
for banks and less than or equal to four for insurance companies) from the same family/
relatives? (Answer “0” if more than two (three or more) for banks and fve or more for
insurance companies).
• Does the company have independent non-executive director(s)? *(Independent directors
should be appointed through the nomination of non- major/minority shareholders and
exclude executive directors, directors fromthe members of family of majority ownership or
other major shareholders).
• Are the positions of the Managing Director (MD) and board chairperson held by the
different individual?
• Whether the MDor one of the topthree executives is fromthe controllingfamily? (If fromthe
controlling family, answer would be “0”).
• Is there any provision of performance-based pay (e.g. salary, bonuses) for the executive
directors and other top-level executives?
• Do you have any system for evaluating the executive director’s performance?
• Does the frm hold at least four board meetings held per year?
• Do the directors attend at least 75 per cent of the board meetings on an average?
• Is there any provision to discipline or evaluate executive management (or has there been
any event of punishment or disciplinary action in the event of mismanagement?)
• Does the frm have an audit committee of the board?
• Do independent non-executive directors chair the audit committee?
• Is the ratio of non-executive directors in the audit committee 2/3 or more?
Disclosure to investors/transparency
• Does the frm have a strong internal audit department?
• Whether the audit committee or internal auditor report is presented to the
AGM/Bangladesh Bank (BB)/Securities and Exchange Commission (of Bangladesh) (SEC)?
• Does the frm have a well-organized investor relations/share department?
• Does the company have an explicit “mission statement” outlining the priority on good
corporate governance?
• Does the annual report of the company incorporate a section outlining the performance in
implementing corporate governance principles?
• Does the management disclose three-or fve-year key data on fnancial performance?
• Does the company publish annual reports within fve months of the end of the fnancial
year?
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• Does the company publish half-yearly reports within one month of the end of the half-year?
• In the annual report clear and informative? (Based on the researchers’ evaluation of the
annual report).
• Does the company have a website with updated fnancial results and announcements?
• Does the company disclose market-sensitive information consistently and punctually?
• Has the researcher had good access to the concerned person/senior management in terms of
promptness to respond, suffcient time and detailed information without misleading?
(Based on researchers’ personal experience during the feld survey).
Responsibility towards the stakeholders
• Does the frm provide suffcient employee training programme?
• Does the frm contribute to different community development or social welfare
programmes?
• Has there been any initiative taken to protect the environment from pollution?
• Does the frm provide satisfactory employee welfare programme (e.g. retirement beneft
housing scheme, transportation, schooling/scholarship of employee’s children)?
• Is that true that the frmcontribute to the welfare programme for the disabled/handicapped
people?
• Has there been any initiative to promote education?
Corresponding author
Faizul Haque can be contacted at: [email protected]
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