Agency-linked risk management with ownership and board sub-committee governance: Evidence from an OECD economy
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Al Farooque, Omar Article Agency-linked risk management with ownership and board sub-committee governance: Evidence from an OECD economy Journal of Risk and Financial Management Provided in Cooperation with: MDPI – Multidisciplinary Digital Publishing Institute, Basel Suggested Citation: Al Farooque, Omar (2021) : Agency-linked risk management with ownership and board sub-committee governance: Evidence from an OECD economy, Journal of Risk and Financial Management, ISSN 1911-8074, MDPI, Basel, Vol. 14, Iss. 10, pp. 1-16, https://doi.org/10.3390/jrfm14100472 This Version is available at: https://hdl.handle.net/10419/258576 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/
J.RiskFinancialManag.2021,14,472.https://doi.org/10.3390/jrfm14100472www.mdpi.com/journal/jrfm Article Agency‐LinkedRiskManagementwithOwnershipandBoard Sub‐CommitteeGovernance:EvidencefromanOECD Economy OmarAlFarooque UNEBusinessSchool,UniversityofNewEngland,Armidale,NSW2351,Australia;[email protected] Abstract:Fromariskmanagementperspective,thisstudyexaminestheroleofownershipand boardsub‐committeegovernanceondirectmeasuresofagencycostsinasmallOECDeconomy— NewZealand.UsingLogisticandOLSregressionapproaches,twoproxiesofdirectagencycostsare testedonapooledsampleof466firm‐yearobservationsrangingfrom2012to2018.Thestudypro‐ videsevidencethatinsiderownershipconcentrationoutperformsoutsiderownershipconcentration inconstrainingagencycosts.Moreover,auditcommitteeindependencecanalsoeffectivelydeter agencycosts.Thesefindingssuggestthatbothinsiderownershipconcentrationandauditcommit‐ teestructureareimportantriskmanagementmitigatingfactorfordeterringagencycostsinNew Zealandcompanies. Keywords:riskmanagement;directmeasuresofagencycosts;ownershipconcentration; boardsub‐committeestructure;NewZealand JELClassification:G30;G34 1.Introduction Weinvestigatetheroleofownershipandboardsub‐committeegovernanceon‘di‐ rect’measuresofagencycostsamongpubliclylistedcompaniesinNewZealand(hereaf‐ ter,NZ)fromariskmanagementviewpoint.Thestudyismotivatedbythefactthatno priorstudiesexaminethisrelationshipwhenthereareconsiderabledebatesandscepti‐ cismsintheliteratureregardingtheperformance,accountabilityandcommitmentofra‐ tionalbehaviouroftheboardofdirectorsub‐committees(Wintoki2007)andwhetherin‐ dependentdirectorsalwaysfulfiltheirdutiesasexpected.Liuetal.(2016)arguethatthe effectivenessofindependentdirectorshaslongbeendiscussedanddisputed,yetthereg‐ ulatorshavehighexpectationsonindependentdirectors,asevidencedintheSarbanes‐ OxleyAct’shighlightingofindependencedirectors’roleintheboardsandauditcommit‐ tees.Inthispaper,wefocusonalternativeownershipconcentrationandauditcommittee variables’relationshipswithagencycostsinarelativelysmallstockmarketinOECD countries—NewZealand,whichisrelativelyunder‐researched,toreinforcingmonitoring andcomplementingtheroleofboardandownershipindeterringagencycosts.Because auditcommitteemembersareindependentoutsidedirectorsandfinanciallyliteratewith auditingknowledge,theyaremorelikelytomakeexpertjudgmentsthanotherboard members.Assuch,anindependentauditcommitteeismorecommittedinrestraining agencycostsandtheirmembersoughttobeaversetounethicalpractices.Inaddition, bothinsiderandoutsiderownershipconcentrationcanplayvitalrolesinrestraining agencycostsfromtheviewpointsofincentivealignmentandmonitoring. Theagencyproblemisunderpinnedbythedivorceofownershipandcontrolwithin firmsandthenon‐alignmentofinterestsbetweencontrollingandnon‐controllingparties. Citation:Farooque,OmarAl.2021. Agency‐LinkedRiskManagement withOwnershipandBoard Sub‐CommitteeGovernance: EvidencefromanOECDEconomy. J ournalofRiskandFinancial M anagement14:472.https://doi.org/ 10.3390/jrfm14100472 AcademicEditor:ThanasisStengos Received:25August2021 Accepted:1October2021 Published:7October2021 Publisher’sNote:MDPIstaysneu‐ tralwithregardtojurisdictional claimsinpublishedmapsandinstitu‐ tionalaffiliations. Copyright:©2021bytheauthor.Li‐ censeeMDPI,Basel,Switzerland. Thisarticleisanopenaccessarticle distributedunderthetermsandcon‐ ditionsoftheCreativeCommonsAt‐ tribution(CCBY)license(http://crea‐ tivecommons.org/licenses/by/4.0/).
J.RiskFinancialManag.2021,14,4722of16 Avastmajorityofliteraturedocumentsthatagencyproblemsmayarisebetweenprinci‐ pals(owners)andagents(managers)(TypeI)(BerleandMeans1932;JensenandMeckling 1976;FamaandJensen1983),andbetweenprincipals(controllingshareholders)andprin‐ cipals(minorityshareholders)(TypeII)(ShleiferandVishny1986;ShleiferandVishny 1997;LaPortaetal.2000;VillalongaandAmit2006).Bothtypestypicallyincurhugecosts tocorporatefirmsinvolvingthecontroller’sprivatebenefitsthataredetrimentaltothe valueofthefirm.ShleiferandVishny(1997)contendthattheprivatebenefitsfromcontrol right(opportunism)arefrequentmanifestationsoftheagencyproblemthatneedstobe addressed.Tomitigateagencycosts,significantmonitoringmechanisms,suchascorpo‐ rategovernanceinstruments(i.e.,avarietyofinternalandexternalmechanisms)arein‐ stalledwithinthefirm(ShleiferandVishny1986).However,regardlessofstagesofeco‐ nomicdevelopmentinmostofthecountries,firmsrelymoreoninternalgovernance mechanisms(suchasownershipstructure,boardofdirectorsub‐committees,andcom‐ pensation)thanexternalmechanismstodealwithagencycosts. Reflectingontheincreasedroleofinternalcorporategovernance,alargepartoflit‐ eraturecontainsanalysisofcorporateboardandownershipasthedominantmechanisms incontrolling‘direct’measuresofagencycosts(Angetal.2000;Brennan2006;Henry2010; WellalageandLocke2011;Rashid2015;Vijayakumaran2019),whereasotherstudiesre‐ porttherolesofmanagerialcompensation,CEO–chairdualityandtenureandnomination committeeonagencycosts(Henry2010;Florackis2008;McKnightandWeir2009).While onlyalimitednumberofstudieshavepresentedevidenceonthedirecteffectsofowner‐ shipandboardsub‐committeegovernancemechanismsonagencycosts.Thesestudies examinetherelationshipbetweencorporateboard/ownershipanddirectmeasuresof agencycostsindifferentjurisdictions,theroleofauditcommitteestructurehasnotyet beenanalysedintheliteratureinaconsistentempiricalfashion.Thecurrentstudyis uniqueinitschoiceofownershipconcentrationaswellasauditcommitteevariablesin contractingagencycostsfromariskmanagementposition.Itaimstofillthisgapinthe empiricalliteratureandcontributetothemanagementliterature. Ourpaperdiffersfrompriorresearchandcontributestoknowledgeinanumberof ways.First,thisstudyisthefirsttomeasure‘direct’agencycostsofNZlistedcompanies thatexamineswhetherownershipconcentrationandauditcommitteestructurevariables aredeterringoraggravatingthiscost.Nopreviousstudyintheliteraturehasattempted toinvestigatetheeffectofalternativeownershipconcentrationandauditcommitteeson thedirectmeasuresofagencycost.Inaddition,nopreviousstudyhasattemptedtomeas‐ ureagencycostsintheNZcontext,althougharecentstudywasconductedintounlisted smallfirms(WellalageandLocke2011).Unlikepriorstudiesondirectmeasurementof agencycosts,thecurrentstudyemploysauditcommitteeindependenceandsizeinorder toobservetheiragencydeterrenteffects.Auditcommitteesizeandcomposition(inde‐ pendence)havenotbeentestedintheliterature1,althoughtheauditcommitteeisactively involvedinoverseeingfinancialreportingandrelatedauditoversightfunctions,rather thantheboard,andmaintainsethicalprinciples.Assuch,itcanbearguedthatauditcom‐ mitteehasanupperhandovertheboardinalleviatingdirectmeasuresofagencycost. Second,NZisanOECDnationwitharelativelysmallstockmarketandsmallnum‐ berofcompanies.AsanAnglo‐Saxonnation,NZ‐basedcompaniesaremoreproneto TypeIagencyproblems,butforahighlevelofownershipconcentration,2theveryexist‐ enceofTypeIIagencyproblemsisalsomorelikelytooccurinNZcompaniesthanin thoseofotherOECDcountries.Todate,muchoftheempiricalresearchon‘direct’meas‐ urementofagencycostsanditsrelationshipwithcorporategovernancehasfocusedon theUS,UKandAustraliancompaniesonly.NZprovidesaninterestingsettingfromthat foundinotherOECDjurisdictions,wherehighlevelsofbothinternalandexternalcon‐ centratedownershipremainsauniquecharacteristicinNZmarket.NZexhibitsadistinc‐ tivenatureofhighownershipcompatibletoAsiancountries,whichprovidestheoppor‐ tunitytotestnewhypothesesthatarenottestableinotherOECDcountries,andthiscould
J.RiskFinancialManag.2021,14,4723of16 leadtodifferent,butinteresting,findingsfromthatofthepriorliterature.Again,owner‐ shipconcentrationisthecentralissueinthetheoryofcorporategovernanceaswellas understandingtherootcauseofagencycosts(ShleiferandVishny1997).Therefore,mu‐ tuallyexclusiveinternalandexternalownershipconcentrationvariablesareusedinthis studytoexaminewhethertheycanreduceorexacerbateagencycostswhereregulationis lessstringent,enforcementisweaker,andprotectionofnon‐controllingshareholdersare lessascomparedtootherOECDcountries(Hossainetal.2001). Third,withtheintroductionof‘CorporateGovernanceCodesandPrinciples’and subsequentamendments,followingotherOECDcountries,itisofinteresttoobservethe progressinmitigatingagencycostsinNZcompanies.Especially,theroleofauditcom‐ mitteesandownershipconcentrationindealingwithdirectmeasuresofagencycostalong withotherboardrelatedvariablesisofparticularinterest. Theremainderofthepaperisstructuredasfollows:Section2reviewspriorstudies anddevelopsthehypotheses;Section3specifiesdataandregressionmodelstested;Sec‐ tion4presentstheresultsofempiricaltestingandSection5discussestheseresultsand providesconcludingremarks. 2.LiteratureandHypothesesDevelopment Empiricalstudieshavefocusedondifferentcontrolmechanisms(suchas,ownership andinternalcorporategovernance,financingpolicyandexternalgovernance)andfirm performanceoutcomesincontributingtoloweringagencycosts.Henry(2010)provides thesedifferentapproacheshighlightedintheliteratureasattributabletomitigationof agencycosts.Theagencymodelsidentifiedinthesestudiesadoptanumberofgovernance mechanismstomaximisefirmvaluebyaligningtheinterestsofagentsandprincipalsand reducingagencycosts.Despitevaluableinsights,thesesubsetsofliteraturearenotdi‐ rectlyrelevanttomeasuringtheproxiesforundesirableagencycosts,ortofactorsinflu‐ encingthelevelsofagencycostsincludinginternalmonitoringinstruments.Todate,rel‐ ativelyfewstudiesundertakeadirectmeasurementofagencycostanditsdeterminants inafirm’ssettingfocusingontheroleofownershipconcentration,internalgovernance andfirm‐specificvariables.Eventhoughonlyalimitednumberofstudiesexplorethere‐ lationshipbetweendirectmeasuresofagencycostsandgovernancemechanisms,thereis evidencethatinternalgovernancemechanismsplayasignificanteffectinalleviating agencycosts. Angetal.(2000)undertookthefirststudytodirectlytacklethemeasurement(or proxyfor)ofagencycosts(thatis,totalsalestototalassetsratioandtotaloperatingex‐ pensetototalsales)anddeterminantsofagencycostsinnon‐listedUSsmallfirms.Con‐ sistentwiththeconvergenceofinteresthypothesis(Jensen1993),theyfindapositivere‐ lationshipbetweenmanagerialownershipandassetturnoverratio,andanegativerela‐ tionshipbetweenmanagerialownershipandexpenseratio,thatisinsiderownershipis foundtobeinverselyrelatedtoagencycosts.Theyalsopointoutthatdebtandexternal bankmonitoringplayaroleinalleviatingagencycosts,whilethenumberofshareholders andnon‐ownermanagersplaysanaggravatingrole.Severalstudiesextendtheworkof Angetal.(2000)indifferentcountriesandwithdifferentdataperiods(suchas,(Doukas etal.2000,2005;SinghandDavidsonIII2003;Chenetal.2011)ontheUS,(Florackis2008) and(McKnightandWeir2009)ontheUK,(Flemingetal.2005)and(Henry2010)onAus‐ tralia,(WellalageandLocke2011)onNewZealand,(Moez2018)onFrench,(Noraveshet al.2009)onIran,(IbrahimandSamad2011)onMalaysia,Rashid(2015)onBangladesh and(Vijayakumaran2019)onChina). SinghandDavidsonIII(2003)investigatethesamemeasuresinUSlarge‐listedfirms bymeasuringagencycosts(totalsalestototalassetsratioandselling,generalandadmin‐ istrativeexpensestototalsales)andhighlightingtheroleofownership,boardanddebtin alleviatingagencycosts.Theirevidenceshowsinsiderownershipandsmallboardshelp alleviateagencycosts,whiledebthasanaggravatingrole;outsideblockownershipmay havealimitedeffectandindependentboardmembershavenoeffectonreducingagency
J.RiskFinancialManag.2021,14,4724of16 costs.Again,bothDoukasetal.(2000)andDoukasetal.(2005)examineagencycostde‐ terminantsforlistedUSfirmsandfindthatgreateranalystfollowingcanreduceagency costs,butnotinstitutionalownership,whilenon‐linearrelationsexistbetweeninsider ownership,leverageandthelevelsofagencycosts.Florackis(2008)alsoexaminestheim‐ pactofownership,board,managerialcompensationandcapitalstructureonagencycosts (i.e.,totalsalestototalassetsratioandselling,generalandadministrativeexpensesto totalsales)inlargeUK‐listedfirms,payingparticularattentiontotheroleofgrowthop‐ portunities.Findingsofthestudyrevealconsistentresultsinalleviatingagencycostsby managerialownership,concentratedownership,debtandcompensation.Florackis(2008) alsoarguesthattheinfluenceofinternalmechanismsonagencycostsmayvarywithfirm growthopportunitiesintheUK.McKnightandWeir(2009)investigatetheimpactofown‐ ershipandgovernancevariablesonthreeproxiesofagencycosts(totalsalestototalassets ratio,interactionoffreecashflowsandgrowthprospectsandthenumberofacquisitions) inlargeUK‐listedcompanies.Applyingarangeofanalyticaltechniques,theyalsofind consistentresultsacrossdifferentmeasures.Inparticular,boardownershipanddebtratio haveaneffectonreducingagencycosts.However,thevariableofCEOtenure,nomination committeeandmajorityofthecommitteebeingnon‐executivedirectorsshowincreased agencycoststhatraisesquestionsregardingtheadoptionofrecommendedgovernance mechanismsinUK‐listedfirms. Flemingetal.(2005)attempttoidentifytherelationshipbetweenagencycostsand ownershipstructureinnon‐listedAustralianfirms,producingsimilarresultstothose foundinAngetal.(2000).Henry(2010)alsoexaminesagencycosts,corporategovernance andownershipstructurerelationshipinlistedAustraliancompaniesforfourdifferent proxiesofagencycosts(thosebeingtotalrevenuetototalassetsratio,sumofcashand marketablesecuritiestototalassetsratio,freecashflowstototalassetsratioandTobin’s Qagencydummy).Theevidencesuggestsanon‐linearrelationshipbetweenboardofdi‐ rector,externalownership,andthelevelofagencycosts;asignificantleadingroleofin‐ stitutionalownershipinreducingagencycosts;amitigatingroleinboardindependence andremuneration;amixedroleinCEO‐chairduality;andlimitedeffectivenessuponfi‐ nancialpolicyvariables.Henry(2010)alsoarguesthatsuperiorinternalgovernancelow‐ erstheextentofagencycosts,whileinternalgovernanceandexternalshareholdinginflu‐ enceslargelysubstituteagency‐mitigatingmechanisms.WellalageandLocke(2011)in‐ vestigatethelinkagebetweenagencycosts,ownershipstructureandcorporategovern‐ anceinunlistedsmallbusinessesinNewZealand.Theirresultsindicatethatownership concentrationhasthemostsignificantgovernanceeffect,withaU‐shaperelationshipbe‐ tweeninternalownershipandagencycosts,whileleveragehasvaryingeffectonagency costsdependingontheproxiesused.Again,usingasampleofFrenchlistedfirms,Moez (2018)findsanegativerelationshipbetweenownershipconcentrationandagencycosts, asmeasuredbyexpenseratio.Almihbash(2021)alsoreportsanegativerelationshipof ownershipconcentrationwithdifferentproxiesofagencycostsmeasures.Inarelated study,ChineloandIyiegbuniwe(2018)andKhanetal.(2020)revealthatadecreasein agencycostsisfollowedbyanincreaseinthelevelofownershipconcentration. Noraveshetal.(2009)examinetheimpactsofgovernancemechanismsonagency costs(inthiscase,interactionofgrowthprospectsandfreecashflows)amongfirmslisted ontheTehranStockExchange,Iran.Theyreportconsistentfindingsofagencycostsmiti‐ gatingeffectsofinstitutionalownershipandpercentageofnon‐executivedirectors,but notfordebtratio.Furthermore,IbrahimandSamad(2011)testagencycosts(totalsalesto totalassetsratioandtotaloperatingexpensetototalsales)andcorporategovernancere‐ lationshipinMalaysianlistedfamilyandnon‐familyfirms.Theirevidencesuggestsasig‐ nificanteffectofboardsizeonbothtypesoffirms,whileindependentdirectorsareeffec‐ tiveinnon‐familyfirmsonlyandCEO‐chairdualitymitigatesagencycostsinfamilyfirms ratherthannon‐familyfirms.Recently,Nguyenetal.(2020)alsoexaminetheeffectof boardsizeontheagencycostsinlistedfirmsinVietnamandfindanegativerelationship
J.RiskFinancialManag.2021,14,4725of16 betweenboardsizeandagencycostsasmeasuredbyassetturnoverratio.Inacross‐coun‐ trystudy,GaraninaandKaikova(2016)alsofindthatlargerboardsizeisrelatedtohigher agencycosts. Again,Rashid(2015)examinestheinfluenceofboardindependenceonfirmagency cost(expenseratio,assetutilizationratioandQ‐freecashflowsinteraction)amonglisted firmsinBangladesh.Thestudyfindsthatboardindependencecanreduceagencycost onlyforassetutilizationratioandthusconcludesthatboardindependenceandother boardattributesdonotreduceallfacetsofagencycostsofafirm.Hearguesthatoutside directors’inabilitytomonitormaybecapturedbytheuniqueinstitutionalsettingofin‐ siderownershipandhighrepresentationontheboard.Asimilarnegativeresultisalso foundbyNguyenetal.(2020)inVietnamforassetutilizationratio.Further,Vijayakuma‐ ran(2019)findthatmanagerialownershipanddebtfinancingworkaseffectivegovern‐ ancemechanismsinmitigatingagencycosts(assetutilizationratioandexpenseratio)in Chineselistedfirms,i.e.,highermanagerialownershipanddebtcanreducetheagency costsofthefirms. Finally,withadifferentfocus,Chenetal.(2011)predictasignificantassociationbe‐ tweenagencyproblemsandcostasymmetry,andthatcorporategovernancemitigatesthe positiveassociationbetweenagencyproblemsandcostasymmetry.Theyfindevidence thatselling,generalandadministrative(SG&A)costasymmetryispositivelyrelatedto themanager’sempirebuildingagencyproblemasmeasuredbyfreecashflow,CEO‐hori‐ zon,CEO‐tenureandcompensationstructure.Theirevidencesuggeststhatcorporategov‐ ernancemechanismsplayanimportantroleinmitigatingtheeffectofagencyproblems onthemanager’scostadjustmentdecisions,asthepositiveassociationbetweenagency problemsandSG&Acostasymmetryismorepronouncedunderaweakcorporategov‐ ernanceenvironment. Hypotheses Theabovestudiessuggestthatcorporategovernancemechanismsplayanimportant roleinmitigatingtheeffectoftheagencyproblemwheredifferentproxiesareusedas directmeasurementofagencycosts.Thecurrentstudy,bycontrast,isuniqueinexamin‐ ingwhetherauditcommitteecharacteristics,alternativeownershipconcentrationand otherboardattributescanreducetheagencycostsofNZlistedfirms. Auditcommitteesareindependentcommitteesassignedtooverseeingacompany’s financialreportingprocess,protectingtheinterestofthefirmanditsvalue.Anauditcom‐ mitteethatiswellstructured,activeandfunctionalcanpreventmanipulationofaccount‐ ingnumbersundertakenbymanagementintheinterestofowners(Xieetal.2003). MangenaandPike(2005)documentthatauditcommitteecharacteristicshaveapositive impactinimprovingthedisclosureprocessandmonitoringeffectivenessofthefirm.In recentyears,auditcommitteeindependencehasbeenseenasoneofthevitalattributesof aneffectivecorporategovernancesystem.Amoreindependentauditcommitteewould beabletoprovidemoreobjectivemonitoringofthecompany’sinternalcontrolsystem. Giventheexistenceofinformationasymmetriesandthepotentialforconflictofinterest betweenmanagersandshareholders,anindependentauditcommitteeoffersvitalgov‐ ernanceinensuringtheintegrityoffinancialstatements,inadditiontothatprovidedby externalauditors.Amoreindependentauditcommitteeislinkedtobettermonitoring (Abbottetal.2004).Eachindependentdirectorintheauditcommitteewillbemotivated toprovidebettermonitoringinordertopreserveanddeveloptheirreputation(Abbottet al.2004).Beasleyetal.(2000)andPersons(2005)findthatauditcommitteeindependence isnegativelyrelatedtothelikelihoodofcommittingfinancialreportingfraudonthepart ofthemanagementtodeceiveshareholders.Amoreindependentauditcommitteeap‐ pearstobemoreeffectiveinperformingitsoversightroleinreducingagencycosts. Again,itisalsoarguedthatalargerauditcommitteeprovidesbettergovernancethan asmallerone,byensuringthereliabilityoffinancialstatements.Alargerauditcommittee hasmoreresourcesandexpertisetooverseethefinancialreportingandinternalcontrol
J.RiskFinancialManag.2021,14,4726of16 systems(Andersonetal.2004),andthuswouldbemoreeffectiveinuncoveringfraud, manipulationandearningsmanagementinthefinancialreportingprocess.Thisinturn leadstothefollowinghypotheses: H1a:Auditcommitteeindependenceisnegativelyassociatedwithagencycosts. H1b:Auditcommitteesizeisnegativelyassociatedwithagencycosts. Ownershipremainsattherootofagencyconflictbetweencontrollingandnon‐con‐ trollingparties(i.e.,betweenmanagersandowners,betweendirectorsandshareholders, andbetweenmajorandminorshareholders)formisalignmentoftheirinterestsandthe presenceofinformationasymmetry.Farooqueetal.(2007)documentthatthealignment ofcontrollingandminorityshareholdersmaynotbecompletelyachieved.Opportunistic behaviourbycontrollingpartiescouldbeminimizedbyaligningtheirworkloadandmo‐ tivationandshareholders’interestmaximization(Jensen1993).AccordingtoBurkartet al.(2003),ownershipstructureisanimportantfactorforalleviatingtheagencyproblems. Outsideownershipconcentrationoflargeshareholdersprovidesincentivestoeffectively monitorfirmbehaviourtomaximisethevalueofshareholdings(ShleiferandVishny1986, 1997;Farooqueetal.2010).Suchincentive‐monitoringaspectstendtoreducetheextent ofagencycosts.Weiretal.(2002)provideevidenceofmonitoringincentivesbyblock holdersforthefirmstoperformbetter.BothFlorackis(2008)andAllam(2018)reportsthat ownershipconcentrationhasastrongeffectinreducingagencycosts. Again,itisarguedintheliteraturethatagencyconflictbetweenmanagersandshare‐ holderscouldbereducedthroughmanagerialownership.Managersowningalargerper‐ centageofshareshavemoreincentivetoaligntheirinterestwithshareholders.Rashid (2016)findsthatmanagerialownershipreducesfirmagencycost,whichisinlinewiththe predictionofagencytheorythathigherinsiderownershipcouldreduceagencycostsand improveperformance(CrutchleyandHansen1989).O’Callaghan(2015)contendsthat thereislimitedevidencetosupportthenotionthatmanagerialownershiphasapositive influenceonagencycosts.Hence,thefollowinghypothesesareexpected: H2a:Boardownershipisnegativelyassociatedwithagencycosts. H2b:Top‐20shareholders’ownershipisnegativelyassociatedwithagencycosts. 3.MethodologyandData 3.1.DataandSample ThisstudyusessecondarydatafromthegovernancestructureofNZlistedcompa‐ nies,includingownershipandfinancialindicatorsfortheperiod2012to2018.Thedata werecollectedfromcompanyannualreportsandDataStreamandOsirisdatabases.Cor‐ porategovernancevariablesweregatheredmanuallyfromcompanyannualreports.The populationofmorethan250companieslistedintheNZStockExchange(NZX)inarange ofindustriesexcludingfinancialfirmsformsanunbalancedpanel.Basedontheavailabil‐ ityofannualreportsandrequireddata,atotalof466observationsweremadewiththe numberofcompaniesrangingfrom46to82overthesevenyearsperiod.Thesefirmsare affiliatedinsixmajorindustrysectors,alongwithonemiscellaneousexample.Tobese‐ lectedasasample,thecompanymusthavebeenactiveduringthesampleperiod;how‐ ever,itisnotnecessaryforacompanytobeincludedacrosstheentireseven‐yearperiod. Table1highlightsbothyear‐wiseandindustry‐wisepercentagedistributionofthesample size.Althoughyear‐wisedistributionseemsequitableovertheperiodexaminedinpar‐ ticularthelateryears,industryconcentrationisevidentwithhighestdominanceinthe servicesector(36.5%)followedbymiscellaneous(18.9%)andprimary(13.5%).
J.RiskFinancialManag.2021,14,4727of16 Table1.Distributionofsamplesize. YearWiseFrequencyPercentageIndustryWiseFrequencyPercentage 2012469.9Energy316.7 20135311.4Goods5612 20145511.8Investment449.4 20157215.5Primary6313.5 20167816.7Property143 20178017.2Service17036.5 20188217.6Miscellaneous8818.9 Total466100Total466100 3.2.MeasurementofAgencyCosts Thisstudyoperationalisesdirectmeasurementofagencycostsasdependentvaria‐ ble,insteadofusingtraditionalbackward‐lookingaccountingperformancemeasures.In theliterature,differentmeasuresofagencycostsareused,suchasassetutilisation/turno‐ verratio(totalsalesorrevenuetototalassetsratio),expenseratio(totaloperatingexpense tototalsalesratio,SG&Atosalesratio),assetliquidityratio(sumofcashandmarketable securitiestototalassetsratio),freecashflowtoassetsratio,Tobin’sQasgrowthprospect, interactionoffreecashflowandgrowthprospects,andnumberofacquisitions.These measuresareeitherbackward‐looking(assetutilisation/turnoverratio,expenseratio)or forward‐looking(freecashflow,Tobin’sQasgrowthprospect)andtherearepotential drawbacksintheformermeasures(see(McKnightandWeir2009)).Moreover,becauseof theasymmetricnature,expenseandcostratiosarelabelledas‘coststickiness’(Chenetal. 2011). Ontheotherhand,forward‐lookingmeasuresareregardedasmoreeffectiveones fordetectingagencycosts.OplerandTitman(1993)arguethatfirmswithhighgrowth prospectsarelesslikelytohaveexcessfreecashflowsbecausetheavailablecashwillbe spentonpositivenetpresentvalueprojects.Doukasetal.(2000)contendthatagencycosts maybeconsideredasafunctionoftheinteractionofgrowthopportunitiesandfreecash flowandfirmsthatcombinelowgrowthprospectsandhighfreecashflowcan,therefore, beregardedassufferingfromhighagencycosts.Because,greaterretentionoffreecash flowswithinthefirmenvisagesasbeingindicativeofpotentialagencyproblemsandthe existenceofagencycosts.Freecashflowisacommonlyusedproxyfortheagencyprob‐ lemandtheresulting‘empirebuilding’incentives(managers’personalutilityfromstatus, power,compensation,andprestige)thatariseswhenthereisamismatchbetweenavaila‐ blecashandgrowthprospects(Jensen1986).Jensen(1986)proposesthatagencycostsare highwhenhighfreecashflowsarecombinedwithpoorgrowthopportunities.Whenfree cashflowishigh,managershavegreateropportunityforoverinvestinginoperationsor negativenetpresentvalueprojects.Bycontrast,whenfreecashflowislow,managers havelessopportunityforempirebuildingandtheyaremorelikelytoavoidnegativeca‐ reerconsequences.Hence,largefreecashflowssuggestgreatermanagerialdiscretionand higheragencycosts. Followingpriorstudies(McKnightandWeir2009;Henry2010;Chenetal.2011),this studyusestwomeasuresofagencycostsfocusingonfirm’sgrowthopportunities:(1) growthprospect(Tobin’sQDummy)and(2)interactionoffreecashflowsandTobin’sQ (FCF*QDUMMY). Thefirstagencycostisthegrowthprospectorindicatorofforward‐lookingfirmper‐ formance(Tobin’sQ),followingHenry(2010).FirmswithTobin’sQratiosgreaterthan 1.00areperceivedaswell‐managedfirmsthatarecreatingvalueforshareholders, whereasfirmswithTobin’sQratioslessthanunityaredestroyingshareholdervaluethat isassociatedwithagencycosts.ItiscalculatedwhereQratioshigherthan1.00identifyas highgrowthfirmsandlowerthan1.00identifylowgrowthfirms.Thisindicatorvariable isassignedavalueofoneifthefirm’sTobin’sQratioisgreaterthan1.00,andisgivena
J.RiskFinancialManag.2021,14,4728of16 valueofzeroiftheTobin’sQratioislessthanorequalto1.00.Thelowergrowthfirms havepoorperformingmanagers,withwastageofresourcesgivingrisetoagencycosts. Thesecondagencycostproxyusedisthe‘interactions’offreecashflowandgrowth prospects(FCF*QDUMMY),followingMcKnightandWeir(2009)andNoraveshetal. (2009).Firmswithloworpoorgrowthprospectscannotutilisetheirfreecashflowsand areexpectedtohavegreatermanagerialdiscretionandhigheragencycosts(Jensen1986). Inotherwords,agencycostsaremorepersistentinfirmswithahighlevelofliquidassets andfreecashflow.Tocapturethiscost,firstly,Qiscalculatedforeachfirmaswellasthe medianvalueforthetotalsamplefirms,followingNoraveshetal.(2009).Thesampleme‐ dianvalue(0.885)isthensubtractedfromtheindividualQratioofeachfirmandaQ indicativevariableisconstructedwithavalueofoneiffirms’Qratiosarelessthansample means(1.345),andavalueofzeroifabovethemean.Secondly,FollowingDoukasetal. (2000)andMcKnightandWeir(2009)freecashflowsaremeasuredasoperatingincome beforedepreciationminustaxesplusinterestanddividendspaidandthenscaledbytotal assets.Finally,aninteractionvariableiscreatedthroughmultiplicationoffreecashflow andQindicativevariables,whichthusbecomesacontinuousvariableshowingfreecash flowvaluesforlowgrowthfirmsandzerovaluesforhighgrowthfirms.Thelowgrowth firmsorhighvalueoftheinteractivevariableisindicativeofhighagencycosts(Florackis 2008).Firmsthatcombinelowgrowthopportunitiesandhighfreecashflowaremore likelytosufferfromhighagencycosts. 3.3.RegressionModel Totestthehypothesesofthestudy,thefollowingregressionmodelisdeveloped: AGENCYCOSTSit=α+β1ACINDit+β2ACSIZEit+β3BSHAREitorTOP‐20SHAREit+ β4BSIZEit+β5BINDit+β6DUALITYit+β7DEBTRATIOit+β8ROAit+β9INV‐RECRATIOit+ β10LNSALEit+IND‐DUM+YEAR‐DUM+εit Table2outlinesthemeasurementtechniqueofthedependentandindependentand controlvariablesintheregressionmodel.Inthecurrentstudy,themainvariableofinter‐ estisauditcommitteeindependenceandsize,followedbyboardshareholdingsandtop‐ 20shareholdings.Top‐20ownershipconcentrationexceedsmorethan50%ownershipof thefirm,whileboardownershipremainsbelow50%level,indicatinghighandlowlevels ofconcentration,respectively.Anumberofcontrolvariablesconsistentwithpriorlitera‐ turehavebeenusedandindustryandyeardummyvariablesareincorporatedinthere‐ gressionmodeltocopewithunobservedheterogeneitymentionedearlier. Table2.Variabledescription. VariableDescription Dependentmeasures: TOBIN’SQDUMMY Qisthemarketcapitalisationplustotaldebtdividedbytotalassets.Qdummyisdenotedas value1ifafirm’sQratioishigherthan1.00indicatingawell‐managedcompanyand0when theratioisequaltoorlowerthan1.00.(Henry2010) FCF*QDUMMY Freecashflow(FCF)istheoperatingincomebeforedepreciationminustaxesplusinterest anddividendspaidscaledbytotalassets.Qdummyisconstructedwithavalueof1ifa firm’sQratioislessthansamplemeans(1.345)indicatingapoorlymanagedcompany,and0 ifabovethemean.InteractionvariableiscreatedthroughmultiplicationofFCFandQ dummyvariables.(Doukasetal.2000;McKnightandWeir2009) Independentmeasures: ACIND Percentageofindependentdirectorstothetotalnumberofdirectorsontheauditcommittee. ACSIZETotalnumberofdirectorsontheauditcommittee. BSHAREBoardshareholdingasapercentageoftotaloutstandingshares,indicatinglowconcentration. (Angetal.2000)
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