A theoretical and econometric evaluation of corporate governance and capital structure in JSE-listed companies

DOIhttps://doi.org/10.1108/CG-08-2018-0272
Published date07 October 2019
Pages1063-1081
Date07 October 2019
AuthorNavitha Singh Sewpersadh
Subject MatterStrategy
A theoretical and econometric evaluation
of corporate governance and capital
structure in JSE-listed companies
Navitha Singh Sewpersadh
Abstract
Purpose A vital resource forattracting investments and boosting economicgrowth is compliance with
corporate-governancepractices. To achieve firm growth, businesses often relyon leverage as a source
of finance, which has tax-saving benefits but could attract financial distress costs. In this context, this
study aims to examine the relationship between corporate governance and the use of debt financing in
JohannesburgStock Exchange (JSE)-listed companies.
Design/methodology/approach This study used a six-yearperiod to examine 713 annual reports in
an unbalanced panel of 130 JSE-listed companies from 2011 to 2016. The empirical econometric
methodologyused was the two-step difference generalisedmethod of moments estimation model,which
is robust in controllingendogeneity and potential bi-directionalcausality between leverage and corporate
governance.
Findings This studyillustrated that corporate governancepractices and firm-specificvariables such as
profitability, firm sizeand firm age have a significant influence on the capital structuredecisions of JSE-
listed firms. This study found support for four out of the six hypotheses. CEO duality and director
ownership are positively correlated with leverage, whereas audit committee independence and board
size are negatively correlated with leverage. This study also found contraventions of board
independence, audit committee independence and CEO duality. The technology sector was the least
compliant, with only 40 per centof their boards being independent. The consumer-servicessector had
the maximumpresence of CEO duality (7 per cent). The industrial sector had the highest averagedirector
ownership(18 per cent). The heath-care sector had 28 per cent of their audit committeesin contravention
of the independencerule.
Practical implications A useful analysis of the theoretical frameworks used by academicwriters are
provided. This study revealedthe governance practices contravened by the relevant sectors,as well as
the associationsbetween corporate governanceand leverage.
Originality/value The study contributesto the literature on capital structureand corporate governance
by an emerging economy such as South Africa (SA) which has not been explored. This study’s results
have key implications for policy-makers, practitioners, investors and regulatory authorities. This study
informs these constituencies about a set of governanceattributes that are catalysts and/or inhibitorsof
leverage.
Keywords GMM, Corporate governance, Agency theory, Information asymmetry, Capital structure,
Managerial opportunism, Audit committee, JSE, Leverage
Paper type Research paper
1. Introduction
The recent public criticism of the external auditors KPMG for their lack of due diligence
(Davies, 2018) has brought renewed interest in the corporate governance arena. Such
focus is reminiscent of the prior high-profile corruption scandals (Enron, World-Com,
Parmalat, and Royal Ahold)that criticised corporate governance and demanded a reformof
legislation on all fronts (Soltani, 2014). Accordingly, there has been a continual revision of
Navitha Singh Sewpersadh
is based at the Department
of Accounting, Economics
and Finance, University of
KwaZulu-Natal, Durban,
South Africa.
JEL classication G30, G32,
G34
Received 22 August 2018
Revised 23 January 2019
Accepted 6 March 2019
The author expresses gratitude
to the two anonymous
reviewers for their time and
effort in refining and improving
this article.
DOI 10.1108/CG-08-2018-0272 VOL. 19 NO. 5 2019, pp. 1063-1081, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1063
the corporate-governance practices over the past two decades in South Africa (SA) as
evidenced by the development of King I to King IV report on corporate governance (King
Committee, 2016). However, there has been an absence of research establishing the
compliance of these governance mechanisms. Particularly in the light of the current
exposure of external auditor inefficiencies in companies which forms part of the
governance role of the audit committee. For that reason, the main objective of this study is
to investigate whether Johannesburg Stock Exchange (JSE)-listed companies comply with
the corporate-governance practices as incorporated in King III. Accordingly, the following
three objectives were identified, firstly to examine the underpinning theories of corporate
governance and capital structure as shown in the literature reviewand develop hypotheses.
Secondly, to determine the compliance with corporate-governance practices in the JSE-
listed companies as illustrated in the descriptive statistics. Thirdly, to examine the role of
corporate-governance in determining the capital structure of firms as presented in the
generalised method of moments (GMM) results. This article is presented as follows: Section
2 presents the literature review, Section 3 details the research methodology, Section 4
highlights the results, Section 5 draws the conclusions, Section 6 offers recommendations
and Section 7 lists out the study’s limitations.
2. Literature review
2.1 Theoretical examination of corporate-governance and capital-structure theories
There is a multitude of corporate-governance theories that propose added corporate-
governance benefits however, the selection of which depends on each country’s strategic
objectives. King IV defines corporate governance as an exercise of ethical and effective
leadership by the governing board towards the achievement of governance outcomes,
namely, ethical culture, good performance, effective control and legitimacy (King
Committee, 2016). However, a theoretical study by L’Huillier (2014) found that the term
“corporate governance” hasdiverging meanings proposed in each of the following theories,
namely, agency, stewardship, resource dependency, managerial hegemony and
stakeholder theories. In addition, the dominant theory was found to be agency theory
(L’Huillier, 2014).
2.1.1 Agency theory. The agency theory surmised that those in control“can serve their own
profits better by profiting at the expenseof the company than by making profits for it” (Berle
and Means, 1932). Jensen and Meckling (1976) expanded the agency theory by clarifying
the key role players in thistheory, as surmised and depicted in Figure 1 below.
As illustrated in Figure 1, significant agency problems fester because investors effectively
owns the firms by virtue of their capital outlay but in actuality have little influence on the
operational activities of the firms, resulting in the risk of the agents acting for their own
benefit rather than for that of the principal (Jensen and Meckling, 1976). However, proper
governance mechanisms safeguard the interests of shareholders and compel agents to
maximise shareholder returns even when they are in conflict with the agent’s self-interest
(Jensen and Meckling, 1976). Jensen and Meckling (1976) elaborates that because both
principal and agent are utility maximisers[1], three sources of agency costs (as shown in
Figure 1) are incurred in attempting to reduce the gap between principal and agent’s
different risk aversion levels and misalignedgoals.
2.1.2 Shareholder theory. The shareholder theory posits that management has a primary
duty of shareholder wealth maximisation (Berle and Means, 1932;Friedman, 1962) through
allocative, productive and dynamic efficiency (Chhotray and Stoker, 2008). Accordingly, a
constricted focus on shareholders’ interim requirement for profit maximisation and market
performance (labelled as a “share-centred view”) is a limitation of the shareholder theory
(Greenwood, 2004), whichhas the negative effects of:
PAGE 1064 jCORPORATE GOVERNANCE jVOL. 19 NO. 5 2019

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