Corporate governance and cost of capital in OECD countries

• DOI: https://doi.org/10.1108/IJAIM-02-2019-0023
• Pages: 1-21
• Date: 28 January 2020
• Published date: 28 January 2020
• Author: Aws AlHares
• Subject Matter: Accounting/accountancy,Accounting & Finance

Corporate governance and cost of

capital in OECD countries

Aws AlHares

Department of Accountancy and Finance,

University of Huddersf‌ield, Huddersf‌ield, UK

Abstract

Purpose –The purpose of this study is to investigate the impactof corporate governance mechanisms on

the cost of capitalin Organisation for Economic Co-operationand Development (OECD) countries.

Design/methodology/approach –A panel data of 240 companiesfrom Anglo-American and European

countries between 2010 and 2017 were used. The ordinary least-squares multiple regression analysis was

used to examinethe relationships. The results were alsorobust to alternative measures and endogeneities.

Findings –The results showed that the corporate governance index and director ownership were

negatively relatedto the cost of capital. Moreover, the study also reports a positive correlation betweenblock

ownershipand the cost of capital.

Originality/value –This study extendedthe corporate governance literature by offering newevidence on

the effect of corporate governance mechanismson the cost of capital. Our f‌indings will help regulators and

policymakersin the OECD countries to evaluatethe adequacy of the current corporate governance reforms to

prevent managementmisconduct and scandals.

Keywords OECD, Corporate governance, Ownership structure, Cost of capital, Institution theory

Paper type Research paper

1. Introduction

In recent years, researchers increased their interest in the subject of corporate governance

(CG) and its possible impacton companies. Consequently, several studies examinedhow CG

associated with a company value (Siddiqui, 2015;Yermack, 1996;Gompers et al., 2003;

Renders et al.,2010;Ntim et al., 2012;Kumar and Zattoni, 2013;Griff‌inet al.,2014), the

corporate social responsibility (CSR) (O’Riordan et al.,2015), the earnings management (Xie

et al., 2003;Yu and Wang, 2018), the compensation (Kaplan, 2012) and the voluntary

disclosure (Yu, 2011;Eng and Mak, 2003). Generally, these studies suggest that CG

positively impactedcorporate performance or company’s value, CSR, earnings management,

compensation and voluntary disclosure. The relevance of these studies is appreciated, as

they highlight the importance of CG in examining different aspects of performance.

However, in spite of their relevance, studies examining to which extent CG drives cost of

capital (COC) remain scarce. More specif‌ically, there is a dearth of studies on how different

corporate governance mechanisms (CGMs) used by companies inf‌luence the COC of these

companies (Cheng et al., 2006;Chenet al., 2011;Matthies, 2013;Tran, 2014). To contribute to

f‌illing this gap, the current study addressed the limitations of previous studies via an

empirical examinationof the effect of CG on COC in Organisation for Economic Co-operation

and Development (OECD)countries.

Weak governance can lead to greater f‌inancing costs for higher debt. Therefore,

shareholders and debt stakeholdersneed better knowledge about the rules on governance in

the f‌irm as well as in the country in which they invested. Moreover, shareholders and debt

stakeholders also needto know whether the companies they invested have good monitoring

Corporate

governance

and cost of

capital

1

Received21 February 2019

Revised12 April 2019

Accepted9 May 2019

InternationalJournal of

Accounting& Information

Management

Vol.28 No. 1, 2020

pp. 1-21

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-02-2019-0023

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

systems to ensure that management truly represents their interests. However, as Fitch

Ratings (2004) point out, although management must be carefully monitored to ensure

protection for the interests of shareholders and stakeholders, stakeholders must bear in

mind that some elements of CG favour shareholders over debt stakeholders. In some

situations, shareholdershave more rights than debt stakeholders(Fitch Ratings, 2004).

Ashbaugh-Skaife et al. (2006) examined the governance attributes designed to increase

the monitoring of management. Their f‌inding showed that, through monitoring,

shareholders improved the decision-making process, prevented management from taking

action of low interest to the shareholders and decreased the imbalance between the

information available to management and the information accessed by the stakeholders

(Ashbaugh-Skaifeet al.,2006).

COC consists of a critical factor in the company’s performance. If the cost of borrowing

funds is high, this will impact a company’s performance. This concept is also related to

other country characteristics.CG varies fundamentally across nations due to the differences

in the legal origin (Siddiqui, 2015). A country with a reliable and effective legal systemwill

have rules and regulations in place to protect the investors’rights. For example, a legal

system that requires companies to provide their shareholders with timely information and

that has rules for enforcing contracts would be considered suitable for investors. La Porta

et al. (2002) examined the equity valuation of f‌irms with different legal systems and

discovered that f‌irms with reliable and effective legal systems tend to have higher equity

valuations and more interestfrom investors.

CG is represented by a corporate governance index (CGI) drawn from the OECD

Principles of CG. Independent variables used in this study include CGI and ownership

structure; these variables are used to show what happens to other variables. Ownership is

further broken down intoblock ownership (BO) and director ownership (DO).Based on that,

the current study aimed to offer information to countries that are not performing the

required level of investment and also provide suggestions for making changes and

implementing mechanisms to establish good CG, thereby attracting more capital based on

companies’performance.

This research, therefore, extended the literature by exploring the effects of CGM on

corporate COC by assessing the levels of compliance with and disclosure of CG principles

contained in the 2004 OECDCode on CG.

2. Corporate governance in the Organisation for Economic Co-operation and

Development countries

Several situations took place in the global f‌inancial environment that concern nations. The

failures of Enron, Worldcom and Tyco in the USA made headlines and, as in with some

earlier failures, caused some concern (Mallin,2007). This situation resulted in the Sarbanes,

2002, which was considered some of the most far-reaching legislations of itskind since the

Great Depression (Litvak, 2006). Both the Cadbury (1992) and the Sarbanes, 2002 revealed

their inf‌luence on the OECD Principles, the fact that the OECD acknowledged in its

publication (Krenn,2014).

The development of CG began becauseof a variety of scandals in OECD countries. These

scandals led the UK to develop the Cadbury (1992),whereas the OECD initial response to the

lack of good governance came in 1999 with the OECD Principles of CG (OECD, 2014). The

US experience with scandals led to the developmentof a governance system, the Sarbanes,

2002, and a few years later the OECD improved its governance principles with the 2004

Principles of CG (Kirkpatrick, 2009).Other OECD countries and international organizations

also contributed to the developmentof this concept.

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