Effect of Capital Structure and Ownership Structure on Corporate Performance - Study on Selected Indian Companies

Abstract

A publicly-held company is not directly managed and controlled by its owners. It is quite impractical that a large numbers of owners having varied fractions of ownership would take direct participation in the management of affairs of a company. Therefore, they employ managers as their agents to represent them in the business corporation and act in their best interests. But, perhaps this separation of ownership and control in the publicly held corporations remains the root cause behind a gamete of corporate governance problems of any country. One of such inevitable corporate governance crises is the existence of a clash of interests between the principals and agents. In this regard, Jensen and Meckling (1976) agency cost theory puts forward a clear view regarding how the managers of a business entity tend to prioritise their self-interests and opportunistically use the free cash flows to satisfy their personal whims against the interest of their employing firms which leads to generation of agency costs. Notably, there is no such clearly prescribed solution of this agency crisis in the literature of corporate finance and governance. However, a number of eminent scholars in this domain produce evidence that, the capital structure and the distribution of ownership among different investors have crucial bearings on the overall quality of corporate governance and also on the agency crisis that arises between managers as the employed agents and the shareholders as the principals. Jensen and Meckling (1976) in their agency theory see the use of debt as a disciplinary force to restrain this managerial opportunistic behaviour and lower owners-managers agency crisis. Grossman and Hart (1982) support the view of Jensen and Meckling (1976) and explain how debt can act as a disciplinary instrument through creating incentive effects from the threat of liquidation which further restrains managerial opportunism. Conversely, Myers (1977) disapproves this view and refers high debt as a potential source of clash of interests between equity and debt holders as a result of default risk which brings another agency cost. Here, debt is supposed to create over-restrictions on investments and ultimately unfavourably affect firm performance. Again, some studies like Shleifer and Vishny (1986), Friend and Lang (1988) show how ownership by institutional investors and big promoters ensures efficient monitoring of managerial decisions and actions from their part and reduce owners-managers agency problem and thereby improve firm performance. Besides, the ownership concentration is also recognised as a crucial internal governance mechanism to control owners-managers agency problem (Shleifer and Vishny, 1986; Friend and Lang, 1988). However, some literatures like Fama and Jensen (1983), Shleifer and Vishny (1997) and Burkart and Panunzi (2006) provide fairly opposite view where ownership concentration is shown as a source of conflict between the interests of minority and majority owners. Besides, owing to the fact that most of manufacturing firms in India are family controlled (Selarka, 2005; Altaf, 2016), the largest owner is supposed to play some special role in the management of affairs of these firms. Under this backdrop, the present study makes a rigorous review of the existing set of literature and finds some crucial research gaps in different aspects like measurement of variable, use of econometric tools, validity of the results etc. The study develops a set of comprehensive research questions and puts highest possible efforts to find satisfactory answer to such questions. To be specific, driven by the inconclusive findings, the study finds it sensible to have some fresh empirical insights which can reveal the dubious relationship between capital structure, ownership structure and corporate performance. The study chooses a set of moderately balanced panel data consisting 91 manufacturing companies listed in BSE 200 index of Bombay Stock Exchange (BSE) of India for the period of 2009 to 2016 to establish the relationship. It introduces a set of independent variables like capital structure of firms, ownership of domestic promoters, ownership of foreign promoters, ownership of institutional investors and ownership concentration. Considering the unique importance of largest shareholder in Indian manufacturing sector, the study also introduces ownership by largest owner as another independent variable. The study measures the corporate financial performance by return on assets, return on equity, Tobin’s Q and market to book value ratio. Besides, the study also introduces a set of firm specific characteristics like age of firm, size of firm, liquidity ratio and assets utilization efficiency etc. as control variables. The study employs both static panel data analysis and dynamic panel data estimations under Generalised Method of Moments framework suggested by Arellano-Bond (1991) to arrive at the robust results. Based on the findings of the panel data analysis the study suggests that, the capital structure choices and various forms of ownership including its concentration are significantly related with the financial performance of Indian manufacturing companies. To be more specific, the capital structure is found to be negatively related with the accounting and market performance of Indian manufacturing companies. Regarding ownership structure, the study confirms a significant and positive statistical relationship between domestic promoters’ ownership and the accounting performance of the sampled companies. However, the study does not evidence any significant statistical association between ownership by domestic promoters and market performance of Indian manufacturing companies. Moreover, the shareholding by foreign promoter is also found to positively influence the accounting and market performance of Indian manufacturing firms. So far as the findings regarding institutional ownership and firm performance is concerned, the study documents a significantly positive impact of institutional ownership on all the variables used to represent the accounting and market performance of the sampled firms for both the estimation techniques. Coming to context of ownership concentration, as the ownership gets concentrated among a circumscribed number of shareholders the expropriation effect is found to become more intense which adversely impacts financial performance of Indian manufacturing firms. However, taking largest owner as a variable for concentration and testing the quadratic relationship, the study finds a U-shaped relationship between ownership concentration by largest owner and accounting and market performance of such firms. The threshold is estimated to be around fifty percent which means the largest shareholders provide active monitoring and their interest is properly aligned with the interest of the firm as a whole when the shareholding touches and crosses a threshold of fifty percent, before which the expropriation effect becomes prominent which arises out of misaligned interests. Therefore, it can be concluded that the corporate entrepreneurs of Indian manufacturing sector who can have mastery over these factors are highly supposed to ensure a vibrant internal governance mechanism and effective regulatory framework which provide them a competitive advantage in terms of low agency problems, minimised internal conflicts, high operational efficiency and improved financial performance. As an important suggestion, the study proposes the need for stricter external regulatory specificities as a complementary to internal regulatory mechanism through ownership concentration and other elements of corporate governance for better financial performance of Indian manufacturing companies. As future research directions, the study strongly recommends sector-specific inquiries and even cross-country investigations on the concerned topic.