Corporate Governance and Capital Structure

Section 1: Researchable Topic Area

Corporate governance is a highly research topic in literature as many of the corporate scandals have taken place because of the gaps in governance. Corporate governance is termed as an array of rules and regulations which helps in directing and controlling the organization Corporate governance is explained as the responsibilities and rights of the organisation’s stakeholder. Corporate governance and capital structure plays a major role in enhancing the wealth of the shareholders. (Velnampy & Pratheepkanth,2012). Moreover, effective corporate governance mechanism assists in assuring the investors regarding receiving of higher return in investments and also provides clear disclosure to the investors regarding the corporate plans and procedures. This reduces the chances of corporate failure, poor structure of corporate and poor internal control system. Corporate governance is explained as the system through which business are directed and controlled wherein an optimal capital structure id the ration between debt and equity for the firms which lowers the financing cost and reduces the chances of bankruptcy(Velnampy & Pratheepkanth, 2012).

There have been greater deals of the empirical research which helps in giving evidences that corporate governance and corporate financial decision are affected by the prevalence of agency conflicts in between shareholders and managers. The activities of corporate governance uplifts the efficiency of organisation with the assistance of effective control and supervision and thus plays a important role in making an alignment of shareholder and managers to reduce the agency conflicts(Velnampy & Pratheepkanth,2012). With proper governance structure, it become easier for an organisation to achieve loans from the investors because functional corporate structures safeguards the shareholders interest, enhances the transparency and also lower the chances of agency conflicts(Kajola, 2008). Those firms with improper governance practices are more likely to face the issues of agency conflicts as managers of such firms could easily achieve benefits because of poor corporate governance structure.

Section 2: Objectives for the Research

The aim of the research is to analyse the effects of corporate governance on capital structure decisions.

The objectives of this research are as follow:

Literature objective

To analyse the concepts of Corporate governance and Capital structure

To review the theories based on corporate governance and capital structure decisions

Methodology objectives

To review the proposed approach applied in the research study

Empirical objectives

To evaluate the effects of the corporate governance on capital structure decisions

structure of the proposal

this research proposal will possess an introduction section which will explain the background the of the research topic. Section 2 will be explaining the different objectives of the research study along with the structure of the proposal. Literature review will then be explained in another section giving emphasis on different theoretical and literature ideas. Section 4 will explain regarding the methodology utilised in this research study and section 5 will be demonstrating the ethics of the research. Section 6 will be explaining the conclusion section and lastly, time chart would be explained in detail with figure.

Section 3: Literature Review

3.1 Corporate Governance

Corporate Governance is defined as structural, functional and procedural for the maintenance and monitoring of the organisation. The term corporate means ‘Institution’ wherein governance means to control, direct and organise. Thus mutually, corporate governance is to direct, manage, lead and have a control on the overall structure while working on an organisation (Firijns & et.al., 2006). There are number of rules, regulations and standards which are utilised to develop and improvise the operation of the regulatory bodies of organisation. It is analysed by Driffield & et.al. (2007) that corporate governance is a framework to monitor, regulate and control the performance of the company by alternative internal and external mechanisms for attaining the objectives. The internal mechanism possesses board composition, non-managerial shareholdings while external mechanism possess the statutory audit and evaluation of stock market (Guest, 2008). The main objective of the corporate government is to confirm the transparency and accountability for those who are being engaged in the implementation of the policy which can also reduce the principal agent conflicts. It ascertains the transparency and accountability prevailing in the organisation by the means of principal-agent issues reduction mechanism. These mechanism possess all the stakeholders who are internal to the firms and organisation and also those who are external to the firms. It is emphasised that corporate governance is termed as a set of mechanism through which the external investors safeguard themselves from any sorts of expropriation done by the internal members (Gill & Mathur, 2011).

Corporate governance is essential implications for the economic growth as proper corporate governance practices helps in reducing the investors risk, attract the capital investment and improvise the company’s performance. It is a vital tool which safeguards the shareholder’s interest (Firijns & et.al., 2006). Corporate governance also helps in proving the structure by which the objective of the company is set and monitor the performance (Guest, 2008).

3.2 Capital Structure

Capital structure is the way through which a business finance its assets by the means of equity and debt. Debt arrives in the form of long term notes payable while equity is divided as preferred stock, retained earnings and common stock. Short-term debt like capital requirements is also termed as capital structure’s part. According to Saad (2010), a capital structure of firms has the ability to trade-off the impacts of bankruptcy costs, charge of agency and different personal and corporate taxes (Driffield & et.al., 2007). According to Modigliani and Miller (1958), value of a firm is not dependent of the financing methods and investment of the company. The M&M theorem had made two propositions wherein proposition I have stated that capital structure is irrelevant to the firm’s value and value of two identical remains the same whereas proposition II stated that financial leverage uplifts the firms value and reduces the weighted average cost of capital(Modigliani & Miller,1958). M&M theorem become a basis for modern thinking on Capital structure which states that in absence on the bankruptcy costs, taxes, agency costs and asymmetric information, the value of the firms is not affected through the ways the firms is financed. They had also stated that irrelevance and tax shield advantage of the capital structure paves a way for the progress of various theories (Modigliani & Miller, 1963). Agency theory gives major emphasis on the conflicts of interest which arise in between the principal and agents when agent’s motives are questionable and there is no prevalence of trust. It is stated that effective decision making is helpful in promoting efficiency and productivity. It has been evaluated by Demsetz & Villalonga (2001) that agency cost theory that capital structure might be helpful in mitigating the agency costs. It is also analysed in this theory that higher leverage reduces the agency costs of the external equity and also enhances the values of firms by boosting the managers to give higher attention to the stakeholders (Kajola, 2008). It is analysed by Jensen and Meckling (1976) that managers of the firms could not provide any alternation in the values of firms just because they have changed the structure of the financial sources. In other word, the firm’s value is independent of the structure of the capital (Jensen and Meckling, 1976). The departure of ownership and control in a firm with effective management might results into applying of inadequate work efforts by the managers, selection of inputs and outputs which match their own preference and maximises the values of firm.

Capital structure decision is vital since the enterprise’s profitability is affected directly through such decisions. The effective selection and usage of capital is key elements in the financial strategy of a firm. The prevalence of the well-developed capital market, intermediary in finance, corporate governance and legal protection assist in debt’s effectiveness. The financial condition of a business organisation depends on the resources and the obligations. Companies performs number of activities to achieve profits and to achieve wealth from the growth however, finance is termed as the essential component for these activities. Various projects fail to operate due to lack of budgets. All though, the Internal Rate of Return(IRR), Net Present Value(NPV) and benefit cost ratio demonstrate the projects as worthy. However, profitability should re-invest in the business for its existence (Demsetz & Villalonga, 2001).

3.3 Relationship between Corporate Governance and Capital structure

Berger (1997) states that it is essential for each of the firm to have good corporate governance practices as it helps in reducing risk for investors, improvise the company’s performance and also attracts the investment capitals. Gill and Mathur (2011) say that there are no specific sets of corporate governance principles which could be used in broad structure as it has its dependence on legal, economic and political environment. However, Modigliani & Miller (1958) considers broad structure as an essential corporate governance mechanism which helps in better performance. moreover, board size is also considered as an effective way to improve the performance to make an effective connection with environment and execute responsibilities in firm. Saad (2010) states that there is a significant relationship in between board sixe and capital structure wherein there is also positive relationship in between financial leverage and board size. Gill and Mathur (2011) have found that those firms with larger board membership possess lower leverage. They assume that larger board size makes a translation in stronger pressure from the corporate board to pursue lower leverage. Moreover, according to Kajola (2008), there is a negative relationship between board size and debt to equity ratio and a positive relationship between capital structure and board size. Lastly, Berger (1997) also stated that effective leadership styles helps in increasing protection against uncertainties and also enhances the ability of the firms to raise the external debt. Thus, it can be stated that there is a significant effects of corporate governance on the capital structure decisions.

Section 4: Details of your research

4.1. Introduction

In this particular chapter of the research study, focus has been mainly on analysing and evaluating the methods that has been selected while completing the investigation on the selected topic in concern. The chapter will further seek to provide justification of the selected methods based on which the reliability and validity of the research can be measured significantly. Correspondingly, the chapter will add aspects such as research approach, research philosophy, research methods, data collection and data analysis tools which is explained below in detail.

4.2 Research Philosophy

One of the important objectives of a research study is the formulation of knowledge. Research philosophy deals with the development of different source of knowledge in context to the research study. Research philosophy can be divided mainly into two forms including positivism and interpretivism. Positivism research philosophy is applied in quantitative studies since it is scientific in nature and seeks to find out new phenomenon based on statistical comprehension (Saunders & et.al., 2009). In similar context, interpretivism research philosophy is mostly relevant for application in qualitative studies owing to the non-quantifiable nature of the same. This particular research seeks to find out or discover a new phenomenon within a research based on theoretical and non-quantifiable information or data (Saunders & et.al.,2009). Thus, the application of interpretivism research would be considered as appropriate. The use of interpretivism philosophy will enable the research to be able to interpret the key element of the study related to Effects of Corporate Governance on capital structure decisions which is the topic for this research study.

4.3. Research Approach

The various elements involved in a research study determines from the selection of suitable research approach. Research approaches can be divided into two types which include inductive research approach and deductive research approach (Richie & Lewis, 2003). Inductive approach which is also known as bottom up approach is mainly applied in qualitative studies where the research starts with the formation of a research question which is further answered in the eventual stage of the study (Richie & Lewis, 2003). On the other hand, deductive research approach which is also known as the top down approach is descriptive in nature and is often applied in quantitative studies owing to the involvement of statistical application. It starts with the formation of research hypothesis, which is further tested in course of conducting the study. In this research study, an inductive research approach has been taken into consideration owing to the qualitative nature of the topic. The key purpose of this research study is to analyse Effects of Corporate Governance on capital structure decision. Correspondingly, past researches conducted on similar topic has largely concentrated on understanding a theoretical perspective of the topic. The application of inductive approach will help the researcher the achieve research answer in eventual stages and achieve required solution. Hence, the selection of inductive approach can be considered as appropriate in this study.

4.4. Research Method

Research methods include all the processes involved while conducting this research study. In general, there are mainly two forms of research methods which comprise of qualitative and quantitative methods. Quantitative research method is deemed to be quite effective and systematic as it enables getting precise and accurate data (Saunders & et.al., 2009). This form of research method includes the application of numerical as well as non-textual data further analysed empirically based on the quantitative data. On the other hand, qualitative study revolves around the concept of understanding or exploring a new phenomenon based on theoretical comprehension. However, the findings drawn from qualitative studies are non-quantifiable and might not be accurate to an extent. Considering the nature of the topic of this study and limitation of quantitative data, qualitative method has been selected. The fact that the research is based on secondary theoretical data has further motivated towards selecting qualitative method for this research study.

4.5. Data Collection

Data collection is also one of the most important parts associated in the process of conducting a research especially considering the contribution it ensures for the research completion. Data are collected from two different sources which comprise of primary data sources and secondary data sources. Primary sources mainly comprise of collecting information from observations, questionnaire survey along with interviews among others. While data collection from secondary resources comprise of journals, literatures and online resources among others. This research study will collect secondary data owing to the qualitative nature of the topic (Salkind, 2010). Variable such as capital structure and corporate governance will be defined at first and then will be described in detail. Furthermore, there was lack of any contact or access for collecting primary in this research, which further prompted for the selection of secondary data as the data collection source. Journals, literatures, government reports and online sources have been considered for reliable and valid data collection for the study at large. Thus, secondary data collection process will be used to collect the data regarding this research study.

4.6. Data Analysis

Data analysis is one of the vital parts in the process of conducting any particular study. It mainly comprises of analysing the collected data based on the tools selected for analysis. Data analysis is dependent on the type of method selected i.e. qualitative and quantitative. Since this research study has considered qualitative method, a thematic analysis approach has been taken into consideration to analyse the data acquired from secondary sources (Salkind, 2010). Themes will be created based on the research objectives and likewise the same will be analysed using the secondary data collected. Though this might hinder the accuracy of the results obtained eventually, but it will certainly serve as key to accomplish of this study considering the nature of the selected topic.

Section 5: Research Ethics

Ethics is termed as an important consideration which is needed while conducting the study of research (Oliver, 2003) Ethics mainly comprise of the moral aspects that is linked with conducting any particular research study. It involves ensuring faithfulness to the legal and moral aspects that are associated with the topic or the overall research approach in general. In general, Ethical consideration is used while collecting both primary and secondary data (Oliver, 2003). This research study has only collected secondary data so it ensured that validity of the research study is maintained. All the collected data are free from plagiarism and all the University’s Ethical Policies and Procedures are followed effectively. Correspondingly, prior ethical approval has taken for this study before conducting the investigation on the selected topic. Furthermore, data manipulation has also been avoided while conducting this study in order to ensure maximum ethicality within the research.

Section 6: Conclusions

This study has given its attention to investigate the impact of corporate governance on the capital structures.it stated that firms financing decision is considered as the major issues faced by the managers. Although, there are various factors which affects the financing decision but corporate governance is termed as major issue. This study also examined the relationship between corporate governance and capital structure of firms and found that impact of corporate governance on the capital structure drives the choice of the capital structures. It is analysed that good governance practices assist in increasing the values of firms. This research makes an indication that corporate governance has a significant impact on the capital structure of the companies and the attributes of corporate governance are effective to explain the decision of finance. Moreover, it is stated that issues of corporate governance have an impact of the capital structure as traditional elements of the corporate governances such as board committees, leadership styles, board meeting, proposition of non-executive directors and board size helps in measuring corporate governance. . It is analysed that the larger broad size makes an adoption of the higher debt policy resulting into positive effects. Thus, it can be said that corporate governance has essential implications on the financial decisions.

It is also analysed that Corporate governance helps the companies by in taking effective management practices, accounting system, effective monitoring, effective regulatory mechanism and utilisation of firms which results into improved performance. It is stated that firms must adopt well-developed structure of corporate governance which can help them to get access to the credits as lesser costs. Hence, it can be concluding that there is a stronger relationship in between capital structure and corporate governance and the policies of capital structures are very useful in enhancing the firm’s values. It is also analysed that stronger monitoring proper mechanism, regulation and rules helps the company to grow in an effective manner.

References

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Demsetz, H. & Villalonga, B. (2001). Ownership and corporate performance. Journal of Corporate Finance,7(2):209-233

Driffield, N. & et.al. (2007). How does Ownership structure affect Capital Structure and Firm Value? Journal Economics of Transition, 15(3): 535- 573.

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Guest, K. (2008). The Determinant of Board Size and Composition: Evidence from the UK. Journal of Corporate Finance, 14(2): 51-72.

Gill, A. and Mathur, N. (2011). “Board size, CEO duality, and the value of Canadian manufacturing firms”, Journal of Applied Finance and Banking, 1(3):280-285.

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Modigliani, F. & Miller, M. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 48, (6):261-297.

Oliver, P. (2003). The Student’s Guide to Research Ethics. Maidenhead: Open University Press.

Richie, J. & Lewis, J. (2003). Qualitative Research Practice: A Guide for Social Science Students and Researchers. London: Sage.

Saad, N.M. (2010). “Corporate Governance Compliance and the Effects to Capital Structure in Malaysia”. International Journal of Economics and Finance, 2(1):29-32.

Velnampy. T & Pratheepkanth, P, (2012). Corporate Governance and Firm Performance: A Study of Selected Listed Companies in Sri Lanka. International journal of accounting research U.S.A.