Impact of Corporate Governance on Leverage and Firm performance: Mauritius

Impact of Corporate
Governance on leverage
and firm performance
A study of firms listed on the Official Market in
Mauritius

A dissertation submitted to University Of Mauritius in partial fulfilment of the
requirements for the degree of BSc (Hons.) Finance (Minor: Law), Faculty of Law
and Management.

Author: Hensley RAMOOGUR

April 2013

Contents
List of tables..............................................................................................................................iv

List of figures............................................................................................................................iv

Acknowledgements....................................................................................................................v

Project declaration form....................................................................................................vi

Abstract ....................................................................................................................................vii

List of Abbreviations ............................................................................................................. viii

Chapter 1: Introduction ..............................................................................................................1

1.1 Purpose of study...............................................................................................................2

1.2 Objectives of the study.....................................................................................................2

1.3 Potential Contributions of the study ................................................................................3

1.4 Delimitations of the study................................................................................................4

Chapter 2: Literature Review.....................................................................................................5

2.1 Introduction of Corporate Governance in Mauritius .......................................................5

2.2 Theoretical Background...................................................................................................6

The Agency Theory ...........................................................................................................7

The Stakeholder Theory.....................................................................................................7

The Stewardship Theory ....................................................................................................8

2.3 Empirical background......................................................................................................9

2.3.1 Corporate governance and Capital structure.............................................................9

2.3.2 Corporate Governance and Performance of Firms .................................................10

2.4 Corporate governance Mechanisms ...............................................................................12

Ownership Structure ........................................................................................................12

Ownership concentration .................................................................................................13

Board Size........................................................................................................................13

Board Composition ..........................................................................................................14

CEO duality .....................................................................................................................14

ii

Audit Committee Independency ......................................................................................14

Disclosure of Stakeholders’ interests; Corporate Social Responsibility (CSR) ..............15

Chapter 3; Research Methodology...........................................................................................16

3.1 Sample/ Research Design ..............................................................................................16

3.2 Independent and Controlling Variables .........................................................................17

3.3 Sources of data...............................................................................................................18

3.4 Proxies used ...................................................................................................................18

3.5 Model Specification .......................................................................................................19

The Multiple OLS Regression .........................................................................................20

Fixed versus Random Effects ..........................................................................................20

F-test for Fixed Effects ....................................................................................................21

Breusch-Pagan LM Test for Random Effects ..................................................................21

Hausman Test for Comparing Fixed and Random Effects ..............................................21

Chapter 4; Data Analysis and Results......................................................................................22

4.1 Descriptive statistics ......................................................................................................22

4.2 Corporate Governance and capital structure..................................................................25

4.2.1 Correlation ..............................................................................................................25

4.2.2 Regression results and discussion...........................................................................27

4.3 Corporate Governance and Firm Performance ..............................................................34

4.3.1 Correlation ..............................................................................................................34

4.3.2 Regression results and discussion...........................................................................35

ROA as dependent ...........................................................................................................35

Tobin’s Q as dependent variable......................................................................................37

Altman Z Score as dependent variable ............................................................................39

Chapter 5 Conclusion and Recommendation...........................................................................40

List of References ....................................................................................................................42

Appendices...............................................................................................................................48

iii

List of tables

Table 1: Number of firms in the sample _________________________________________16
Table 2 List of independent variables ___________________________________________17
Table 3: Dependent variables_________________________________________________18
Table 4: Descriptive statistics _________________________________________________22
Table 5: Correlation capital structure and corporate governance _____________________26
Table 6: Regression results, capital structure and corporate governance _______________29
Table 7 Multiple regression result: leverage and corporate governance ________________30
Table 8 Correlation: Corporate governance and performance________________________34
Table 9 Regression results: ROA and governance (Fixed Effect model) _________________35
Table 10 Regression result for Tobin's Q and governance ( OLS) ______________________37
Table 11 Regression result; Altman Z Score and corporate governance ( OLS) ___________39

List of figures

Figure 1 Hausman test for leverage and corporate governance .......................................................................... 54

Figure 2 Fixed effects (within) estimation for leverage and corporate governance, including F-test................. 55

Figure 3 OLS estimation for leverage and corporate governance ........................................................................ 55
Figure 4 LSDV estimation for leverage and corporate governance ...................................................................... 56
Figure 5 Random effects estimation for leverage and corporate governance ..................................................... 57
Figure 6 LSDV estimation for roa and corporate governance............................................................................... 58
Figure 7 regression, anova and VIF results for Tobin's Q and corporate governance .......................................... 59
Figure 8 regression, anova and VIF results for Altman Z Score and corporate governance ................................. 60

iv

Acknowledgements

I gained a lot of experience and learnt a lot about the corporate world and its
principles when working my research. While browsing through annual report, I became
familiar to standard presentation and guidance of company’s financial statements. Also, I
understood the basics of corporate governance conduct and its importance which deter
fraudulent act. Completing this dissertation was a formidable task of intimidating length and
exacting expectations. Praise the lord on whom I always have faith.

I am desirous for expressing my gratitude to my supervisor, Mr Mudhoo Dourgeswar
who has provided scholastic guidance, utmost cooperation, clues, reviews, feedbacks as well as
critical comments and suggestions to improve my work. His valuable guidance was vital for
the completion of my study.

I am indebted to my parents and family who always encourage and influence me in all
aspects of my life. I am also grateful to my best friends Girish, Keshav, Nivenda, Rajneesh,
Urnesh and Sreshta who are always my best support. I am also thankful to Kunal and Vithi
who always had the words to cheer me up, for providing me all the necessary support and
encouragement. Finally, I wish to express my feeling of gratitude to my fellow classmates.

I have received much useful advice throughout the writing of my dissertation, but all
the faults that remain are obstinately my own. Lastly, I would like to dedicate this
dissertation especially to my grandpa and late grandma for both of them have showered their
love in my upbringing.

(Akshay Ramoogur)

v

Project declaration form

Digitally signed by
Akshay Ramoogur
DN: cn=Akshay
Ramoogur
gn=Akshay
Ramoogur
c=Mauritius l=MU
e=aks_hay08@ho
tmail.com

vi

Abstract

If companies are governed properly and the interests of all stakeholders are taken care
of, a healthy corporate culture could be built. There exist very few research on this field in
Mauritius but yet is a concern. At the heart is the agency theory which according to Jensen, if
agency costs are reduced, the firm performs better and increases firm value. The theory
specifically emphasises on board independence and CEO duality. Furthermore, various
theories about corporate governance were developed but its effect on firm performance is not
quite measurable. The purpose of the present study is twofold. First we have to produce
quantitative information about the present corporate governance system in Mauritius and
critically analyse it. Second, we have to investigate whether there is any relationship between
features of corporate governance and performance of listed firms in the Official Market of
The Stock Exchange of Mauritius, and as such whether the agency problems is minimised in
Mauritius. A sample of 39 firms were analysed for the period 2007-2011. The ‘Ownership
Structure’, ‘Ownership Concentration’, ‘Board Independence’, ‘Board Size’, ‘Independent
Audit Committee’, ‘CEO duality’ and ‘Corporate Social Responsibility’ were considered as
core principles of corporate governance. Debt ratio was used to measure leverage and the
latter proved to have significant relationship with corporate governance. Performance was
measured by Return on Asset, Tobin’s Q and Altman Z-score. Various statistical models,
including correlation, OLS multiple regression, fixed and random effect model were used
coupled with appropriate tests. While most studies used a bivariate analysis, the study
employed a multivariate analysis. Some findings were consistent while some have opposite
views. The study answers some of past study questions like: what impact has corporate
governance created? (Implementation and Impact of Corporate Governance in Mauritius by
Mahadeo, J D and Soobaroyen, T ). Results indicate that the direction and the extent of impact of
governance are dependent on the performance measure being examined. Specifically, the
findings show that board equity, board size and size of the company affects performance.

Keywords: corporate governance, capital structure, firm performance, agency cost, Mauritius

vii

List of Abbreviations

Bank of Mauritius (BoM)

Central Depository, Clearing and Settlement System (CDS)

Companies Act (Co. Act)

Financial Services Commission (FSC)

Global Business Companies (GBC)

Institute of Directors (IOD)

International Accounting Standards (IAS)

International Accounting Standards (IFRS)

Mauritius Institute of Directors (MID)

National Committee on Corporate governance (NCCG)

Net Present Value (NPV)

Report on Code of Corporate Governance (RCCG)

Organization for Economic Co-operation and Development (OECD)

Stock Exchange of Mauritius Ltd (SEM)

viii

Chapter 1: Introduction

Corporate governance has a buzzword in the corporate world. It is the most happening
area where several bodies across several countries are trying to improve the standards of
governance in corporate world. The other aspect which is required to be looked into is
whether standard of governance affect capital structure. As the research is on the corporate
governance related topic, before delving further on the subject, it is important to dwell upon
the concept of corporate governance. According to James Wolfensohn former World Bank
Group President, corporate governance is about promoting corporate fairness, transparency
and accountability (Financial Times, 1999). Effective governance practices decreases ‘control
rights’ of managers which are conferred by the shareholders and creditors. This increases the
likelihood of managers investing in positive net present value projects (Shleifer and Vishny,
1997).

These are foremost to protect the interests of shareholders. Governance is a requisite
for survival and a gauge of how predictable the system for doing business in any country is.
While public attention towards the importance of corporate governance gained momentum
only after the unearthing of major scandals such as Enron(2001)1, AOL(2002), Tyco
International (2002), World Com(2002), and Satyam Computer Services(2009) and more
recently Lehman Brothers (2010) where Ernst & Young ( the Audit firm) fail to disclose
Repo 105 transactions to investors. These scandals have stressed the need and usefulness for
proper analysis of financial statements of companies using different tools so as to detect and
avoid these collapses and to help investors in their investment decisions. It would be wrong to
assume that the concept of corporate governance is something new; the need for strong
corporate governance arose at about the same time as the ownership and management of
corporate entities were separated and the application of agency theories set in as will be
discussed later in details in literature chapter.

1
The ENRON Scandal is considered to be one of the most notorious within American history. ENRON
scandals; deregulation, misrepresentation, fraudulent energy crisis, embezzlement. Due to the actions of the
ENRON executives, the ENRON Company went bankrupt.

1.1 Purpose of study
Following these corporate failures and scandals, the last two decades witnessed an
increasing intensity of researches on corporate governance. Firms with weaker standards tend
to face more agency problems which weaken their foundation for better performance.
Furthermore, it helps management in decisions like board compositions, mergers and
acquisitions. There are many researches which targeted the effect of CEO duality, Board
Size, Board Balance, Ownership, and Board Dedication on Firm’s Performance and capital
structure, but few on in Mauritius. Capital structure decisions are some of the core decisions
of today’s businesses. The inclusion of debt in the capital structure may affect the overall
performance and market value of the company. This research will provide the policy makers
with insight to the type of corporate governance which may ensure an optimal capital
structure.

This study tries to analyze the different variables of corporate governance to find out
their impacts on financial performance and find whether there is relationship between
governance and performance.

1.2 Objectives of the study
The goal of this research is twofold. First, it gathers, for the first time, quantitative
measures of the corporate governance and performance ratios of companies in Mauritius. A
wide array of official and private sources was used for this research. Second, we test the
predictions of recent theories based on theoretical framework and hypotheses. There are
many researches which targeted the effect of CEO duality, Board Size, Board Balance,
Ownership, and Audit on Firm’s Performance on developed and emerging countries.

(Note that the analysis will break into two parts: corporate governance and capital structure,
and, corporate governance and firm performance explaining ‘/’ in the hypotheses)

H1: There is a significant relationship between ownership structure and firms' capital
structure / firm performance

H2: There is a significant relationship between ownership concentration and firms' capital

2

H3: There is a significant relationship between board size and firms' capital structure / firm
performance

H4: There is a significant relationship between board independence and firms' capital

H5: There is a significant relationship between independent audit committee and firms'
capital structure / firm performance

H6: There is a significant relationship between CEO duality and firms' capital structure / firm
performance

H7: There is a significant relationship between social responsibility and firms' capital

1.3 Potential Contributions of the study
This study contributes to the existing literature through many sites which may be
elaborated, as follows:

1- A practical based, practitioner’s suggested, and corporate governance variable for a
developing sector is the core achievement of this study.

2- Inclusion of a separate factor of corporate governance in capital structure is the other
major contribution of this study.

3- There are few researches on corporate governance and firm performance in Mauritius, and
I intend to provide scope for the study with corporate variables whilst others followed the
scorecard approach.

3

1.4 Delimitations of the study
Despite of some efforts, there are several limitations of this study; they can be
mentioned as under:

1. The study is conducted mainly by depending upon the secondary sources of information

2. The corporate governance study is calculated by calculating a specific variable for each
corporate governance element which has a scope for further research.

3. Limitations of Financial Statement Analysis

Financial statement analysis is widely used but it has two major drawbacks. Firstly it
involves the comparability of financial data between companies and secondly the need to
look beyond ratios.

4. The study was delimited to the period of 2007 to 2011.

5. The inclusion of all sectors in the same sample did make data interpretation difficult in
Chapter 4.

4

Chapter 2: Literature Review
2.1 Introduction of Corporate Governance in Mauritius
Among African companies, corporate governance is often regarded as a weak link to
performance. Mauritius has adopted a more or less a free market economy as economic
model. Private investment is the heart of the system. Government provide incentives and
infrastructure through various forms and sets the rules. Basic finance theory differentiates
between those having an excess of money and those in need of money. Savings can be both at
individual and at institutional level. A system of corporate governance is vital to keep the
balance between the interests of the investors (individuals and institutions), the entrepreneur
(and his family), the management and other stakeholders, as does the sustainability of the
business. Governance was an issue in Mauritius as elsewhere for many years. However, it
was in 2001 that Mr Sushil Kushiram, the then Minister of Finance, Economic Development
and Financial Services, and his government decided, it was time to create a legal and
institutional framework to enhance corporate governance and as part of the modernization of
the Mauritian Economy

From 2001, began a number of reforms, laws were revised and new laws were enacted
and also institutions were set up. The Committee of Corporate Governance came to birth and
the Minister asked Mr Tim Taylor to chair it; the Listing Rules of the SEM were reviewed; a
new Companies Act was passed and International Accounting Standards (IFRS) were
introduced. Mauritius has taken the lead in lending institutional support to corporate
governance. The National Committee on Corporate Governance (NCCG) was created under
the aegis of the Financial Reporting Act2, and in turn this spawned the creation of the
Mauritius Institute of Directors. The process continued and the Securities Act, the Insurance
Act and the Insolvency Act were passed. In 2001, the Financial Services Commission3 was
set up, The NCCG, with the help of Prof. Mervyn King, published the Code of Corporate
Governance 4in 2003, and also issued “Guidance Notes for State-Owned Enterprises” in
2006. In 2009, the “Statutory Bodies (Accounts and Audit) Act” was amended to make it

2
THE FINANCIAL REPORTING ACT 2004: S63-71 :PART V - THE NATIONAL COMMITTEE ON
CORPORATE GOVERNANCE
3
FSC regulates and licenses financial and non-banking activities in Mauritius
4
The Report comprises eight sections dealing with - (i)Compliance and Enforcement, (ii) Boards and
Directors, (iii) Board Committees, iv) Role and Function of the Company Secretary, (v) Risk
Management, Internal Control and Internal Audit, (vi) Auditing and Accounting, (vii) Integrated
Sustainability Reporting, and (viii) Communication and Disclosure.

5

compulsory for statutory bodies to include in their annual reports a corporate governance
report in accordance with the National Code of Corporate Governance, this being effective as
from 2011.

Mauritius is often referred to for its economic success story. Many economists and
other researchers have marvelled at the spectacular transformation of the country. Ali Zafar,
macroeconomist at the World Bank pointed out in a recent report5 that this was due to a
combination of political stability, strong institutional framework, low level of corruption, and
favourable regulatory environment. Not surprisingly these fundamentals are reflected in
governance indices like the Mo Ibrahim Index, which for three consecutive years ranked
Mauritius as first in Africa. It is difficult to say whether the Mauritian miracle can be
attributed solely to good governance, but when contrasted with many other countries,
including the highly developed ones, it is quite tempting to believe that this may well be the
case. The financial crisis has been attributed, not only to a failure of the state level to manage
and control systemic economic risks through timely policies and regulations but also poor
corporate governance.

.

2.2 Theoretical Background
There is no such accepted theoretical base for corporate governance, (Carver, 2000;
Tricker, 2000; Parum, 2005; Larcker,; Harris and Raviv, 2008). Citing Pettigrew (1992),
Tricker (2000) and Parum (2005) argued that corporate governance research lacks coherence;
either is theoretically, empirically or methodologically since the modern organisation is
complex. Per se, a number of alternative frameworks for corporate governance came to light
from different disciplines like economics, management and even psychology and sociology.
There are three well known corporate theories/frameworks namely the Agency Theory (from
1930’s onwards), the Stakeholder Theory (from 1970’s onwards) and the Stewardship
Theory (from the 1990’s onwards). Using various terminologies, these frameworks view
corporate governance from different perspectives. However, these frameworks often overlap
theoretically and do share significant commonalities (Solomon and Solomon, 2004)6.

5
Mauritius: An Economic Success Story, January 2011
6
For example, agency theory and transaction-cost economics share key assumptions and approaches in
conceptualizing boards (Stiles and Taylor, 2002), and it is often difficult to clearly distinguish between the
concept of stewardship and trusteeship (Learmount, 2002).

6

The Agency Theory
Emanating from the classical thesis on The Modern Corporation and Private Property by
Berle and Means (1932), this model was developed by Jensen and Meckling (1976) and
further by Fama and Jensen (1983).It is perhaps starting point and the most known model.
The theory surges to explain the agency problem and the costs associated with it. The
discussion about the need for improving the governance of the firms is a response to many
cases of expropriation of shareholders’ wealth by the top executives, but also by the majority
shareholders at the expense of the minority shareholders. This phenomenon describes quite
well the agency problem, when the agents take decisions maximising their own interests
rather maximising shareholder’s value (the same apply to the appropriation by the majority
shareholders of the private benefits of control). Solutions to agency problems involve
establishing a ‘nexus’ of optimal contracts (explicit as well as implicit) between the owners
and management of the company. The key issues towards addressing opportunistic behaviour
from managers within the agency theory are board independence and CEO duality. It is argued
that this reduces conflict of interest and ensures a board’s independence in monitoring and
passing fair and unbiased judgement on management. CEO duality reduces the concentration of
power in one individual and thus greatly reduces undue influence of particular management.

The Stakeholder Theory
By expanding the spectrum of interested parties, the stakeholder theory stipulates that, a
corporate entity invariably seeks to provide a balance between the interests of its diverse
stakeholders in order to ensure that each interest constituency receives some degree of
satisfaction (Abrams, 1951). The stakeholder theory therefore encloses creditors, customers,
employees; banks, governments, and society are regarded as relevant stakeholders. Related to the
above discussion, John and Senbet (1998) emphasize the role of non-market mechanisms such as
the size of the board, committee structure as important to firm performance.

Stakeholder theory has infiltrated the academic dialogue in management and a wide
array of disciplines. Much attention has been paid to some basic themes that are now familiar
in the literature – 1.that firms have stakeholders and should proactively pay attention to them
(i.e., Freeman, 1984), 2.that stakeholder theory exists in tension (at least) with shareholder
theory (i.e., Friedman, 1970), 3.that stakeholder theory provides a vehicle for connecting
ethics and strategy (i.e., Phillips, 2003), and 4.that firms that diligently seek to serve the
interests of a broad group of stakeholders will create more value over time (i.e., Campbell,

7

1997; Freeman, 1984; Freeman, Harrison & Wicks, 2009). However, there are so many
different interpretations of basic stakeholder ideas that theory development has been difficult
(Scherer & Patzer, 2011). An extension of the theory called an enlightened stakeholder theory
was proposed. However, problems relating to empirical testing of the extension have limited its
relevance (Sanda et al., 2005).

The Stewardship Theory

Relative to agency theory, stewardship theory has received limited attention as a
theoretical model for explaining the relationship between firm managers and firm owners.
Human beings are seen as self-interested, opportunistic, utility maximisers whose primary
focus is economic benefit (Jensen and Meckling 1976). According to the stewardship theory, a
manager’s objective is primarily to maximize the firm’s performance because a manager’s need
of achievement and success are satisfied when the firm is performing well. A tension between
principal and agent occurs as both parties cannot maximize their economic utility in the
principal-agent relationship. Stewardship theory addresses the underlying agency theory
assumption that there is a tension between the risk propensity of principals and their agents
whereby agents focus their actions upon mitigating their personal risk at the expense of
principals. Stewardship theory assumes that managers behave as trustworthy stewards of the
organization and focus on the collective good of the constituents in the firm regardless of the
manager’s self-interests (Davis et al. 1997, Donaldson and Davis 1991).

The stewardship theory considers the following summary as essential for ensuring
effective corporate governance in any entity: 1. the involvement of non-executive directors
(NEDs) is viewed as critical to enhance the effectiveness of the board’s activities, 2. the positions
of CEO and board chair should be concentrated in the same individual. The reason is that it
affords the CEO the opportunity to carry through decision quickly without the hindrance of undue
bureaucracy. 3. Small board sizes should be encouraged to promote effective communication and
decision-making even though it fails to find an optimal ‘small’ board size?

Nevertheless, none of the above theories or frameworks offers a clear picture of the
exact direction of the causality between governance and capital structure nor firm
performance. Governance theories suggest that strong shareholder rights can mitigate agency
problems and, as a consequence, increase firm value. However, shareholders rights can be
restricted by the managers. Therefore, no causal inferences can be drawn from the theory

8

since it is not clear that there is a causal relationship and its direction. Due to this lacuna in
the theoretical framework, many researchers have been showing empirically that governance
drives performance. However, they point out the limitations of their results warning that they
may not be robust to some unobservable firms’ characteristics. In the sequence, an empirical
review on the field of corporate governance is provided, giving special attention to the
relationship between governance and performance.

2.3 Empirical background
2.3.1 Corporate governance and Capital structure
This study has been conducted with the hypothesis that a relationship may exist
between corporate governance and capital structure. The selection of capital structure is a
topic which has been under discussion for a long period of time. Modigliani and Miller
(1958) propounded a theory of capital structure, known as MM theory, which states that there
is no optimal capital structure because each structure is based on different assumptions like
perfect a market, no taxes, etc. After their research, a lot of researchers in the world tried to
find out different determinants of capital structure. (Kim & Berger (2008) and Toy et al.
(1974) found growth, profitability, and international risk as the determinants of capital
structure. After this study, firm size, industry class, business risk, and operating leverage
were tested by Ferri and Jonnes (1979) as the possible determinants of capital structure.
Titman and Wessel (1988) found profitability having negative relationship with capital
structure. They also found that small firms rely on short term financings. Laporta at al. (1998)
worked to find out why firms have different financing behavior in different countries and
found that different legal protection in different countries explains the firms’ financing
behaviors. In a country where legal protection is weak, the chances of agency conflict
increases. In this situation, leverage can play a role to alleviate the agency cost between
managers and shareholders (Grossman and Hart, 1982).

Various research studies have also tried to find out the effect of ownership structure in
determination of optimal capital structure. Slutz (1988) developed a model for firms’ targets,
capital structure, and ownership structure. Extensive research is found on different corporate
governance characteristics with capital structure decisions (Wen, Rwegasira and Biderbeek
(2002). Jiraporn and Liu (2008) conducted a study to find the relationship between a

9

staggered board and capital structure. They found that the companies which have a staggered
board are less leveraged than the other boards. Berger et al (1997) conducted a study to find
the relationship between board size and capital structure decision and found that there is a
negative relationship between board size and leverage and also found a positive relationship
between the presences of outside directors on boards with debt in the capital structure. Lipton
& Lorsch (1992) argued that there is a significant relationship between board size and capital
structure. Jensen (1986) found that big boards have larger debt in their capital structure..
Managerial equity proportion has also been studied by various researchers and both positive
and negative evidence has been found with capital structure. Agrawal and Mandelker (1987)
and Amihud et al. (1990) found a positive relationship between these two variables, while
Friend and Hasbrouk (1998) found a negative relationship between these two variables.

2.3.2 Corporate Governance and Performance of Firms
A recent study was carried by Lamport M J, Latona M N, Seetanah B and Sannassee
R V on the impact of corporate governance on firm performance in Mauritius. The study used
Taffler Z-score as proxy for performance and calculated a corporate governance score. They
found no significant relationship between corporate governance and firm performance.
However this alone cannot conclude the hypothesis. No more such study are found for
Mauritius. A number of studies exist though about the implementation of corporate
governance. Thus, the study will also attempt to answer this hypothesis.

Empirical studies from various countries are abundant. Some researchers had looked
for a direct evidence of a link between corporate governance and corporate performance
while other researchers have tried to study the correlation between the corporate governance
and firm’s performance. Much of the previous literature has shown a positive relationship
(Brickley et al, 1994; Brickley and James, 1987; Byrd and Hickman, 1992; Chung et al,
2003; Hossain et al, 2000; Lee et al, 1992; Rosenstein and Wyatt, 1990; Weisbach, 1988)
between governance and firm performance assuming that governance is an independent
regressor, i.e. it is exogenously determined, in a firm performance regression. This would
suggest that firms are not in equilibrium, and improvements in governance would lead to
improvements in firm performance. On the other hand, other studies have reported negative
relationship between corporate governance and firm performance (Bathala and Rao, 1995;
Hutchinson, 2002) or have not found any relationship (Park and Shin, 2003; Prevost et al.
2002; Singh and Davidson, 2003; Young, 2003). Demsetz and Lehn (1985).

10

Several explanations have been given to account for these apparent inconsistencies.
Some have argued that the problem lies in the use of either publicly available data or survey
data as these sources are generally restricted in scope. It has also been pointed out that the
nature of performance measures (i.e. restrictive use of accounting based measures such as
return on assets (ROA), return on equity (ROE), return on capital employed (ROCE) or
restrictive use of market based measures (such as market value of equities) could also
contribute to this inconsistency (Gani and Jermias, 2006). Furthermore, it has been argued
that the “theoretical and empirical literature in corporate governance considers the
relationship between corporate performance and ownership or structure of boards of directors
mostly using only two of these variables at a time” (Krivogorsky, 2006). For instance,
Hermalin and Weisbach (1991) and McAvoy et al. (1983) studied the correlation between
board composition and performance, whiles Hermalin and Weisbach (1991), Himmelberg et
al. (1999), and Demsetz and Villalonga (2001) studied the relationship between managerial
ownership and firm performance.

To address some of the aforementioned problems, it is recommended that a look at
corporate governance and its correlation with firm performance should take a multivariate
approach. The present study adds to the literature by employing both market based and
accounting based performance measures such as return on assets and Tobin’s Q and test the
relationship between them and selected governance variables. In addition to board
characteristics, we also include board activity intensity as well as audit committee practices
and characteristics, social responsibility as an extended arm of governance. We combine
survey and publicly available governance data to broaden the scope of governance variables.

11

2.4 Corporate governance Mechanisms
Recent studies have used different kind of approaches to measure corporate
governance. Fundamentally, each research possesses its own way of evaluating corporate
governance, some constructed indices, and others calculated corporate governance absolute
variables. For example Klapper and Love (2004) evaluate the differences in the governance
practices of 14 companies in emerging markets through the use of a corporate governance
index developed by the Credit Lyonnais Securities Asia (CLSA), an investment bank.
Gompers Ishii and Metrick (2003) used different provisions to construct an index.

The present study will attempt to use rather a variable for each corporate governance
item. Each item/variable is assessed as used in previous researches in this field of study. This
is further elaborated below and in chapter 3(see table xxx). In this study, the researcher’s
corporate governance variables are Ownership structure, Ownership concentration, Board
size, Board independence, Audit Committee independency, CEO duality, and finally Social
responsibility. The following literature provides a summary.

Ownership Structure
Ownership structure has been under extensive discussion for a long time. Several
authors have given reasons for the difference in this ownership structure. Sun and Tong
(2003) indicated that different kind of ownership exists: legal ownership, employee
ownership, board ownership institutional ownership, and public ownership. Structure was
measured by board ownership as conducted by Eric Sevrin (2001). Jensen and Meckling
(1976), Fama and Jensen (1983) and Shleifer and Vishny (1986), among others, have
suggested that the structure of equity ownership has an important effect on managerial
incentives and firm value. Kim and Sorenson (1986), and Agrawal and Mandelker (1987) for
American firms; Friedman et al. (2003) for Asian firms; Boubaker (2007) for French firms;
and Holmen et al. (2004) for Swedish firms all find evidence of a positive relationship
between debt and control.

12

Ownership concentration

Ownership concentration will be identified as major 10 shareholders of a company or
holding equivalent of 5% or more of the outstanding shares. Shlifer and Vishney (1997)
analysed how ownership concentration is one of the important determinants of corporate
governance. Several views of ownership concentration are found in the literature. Some say it
is good, and Johnson et.al (2000) evaluated ownership concentration as a source of
tunnelling; large shareholders become the managers and cause serious agency problems for
minority shareholders. Laporta et al. (1999, 2002) regarded ownership concentration as one
of the big agency problems in the countries where legal protection is weak. Most prior
evidence shows that firms with high ownership concentration have higher leverage levels
(Grossman and Hart, 1986; Anderson et al., 2003). Controlling shareholders prefer debt to
equity financing, since they tend to maintain their level of voting control for a given level of
equity. Again mixed results were found as discussed above.

Board Size

Limiting board size to a particular level is generally believed to improve the
performance of a firm because the benefits by larger boards of increased monitoring are
outweighed by the poorer communication and decision making of larger groups. Empirical
studies on board size seem to provide the same conclusion: a fairly clear negative relationship
appears to exist between board size and firm value (Rouf , 2011). Lipston and Lorsh (1992)
and Jensen (1993) also indicate that the larger board is less effective. Berger et al.(1997)
found that larger board of directors result in low leverage levels. Dalton and Dalton(2005)
found superior performance resulted from larger boards while Hermalin and Wiesbach (2003)
and Bhagat and Black (1999) proposed an opposite view.

13

Board Composition

A board is more independent if it has more non-executive directors (NEDs). As to
how this relates to firm performance, empirical results have been inconclusive. In one
breadth, it is asserted that executive (inside) directors are more familiar with a firm’s
activities and, therefore, are in a better position to monitor top management. On the other
hand, it is contended that NEDs may act as “professional referees” to ensure that competition
among insiders stimulates actions consistent with shareholder value maximization (Fama,
1980). Some studies find better performances for firms with boards of directors dominated by
outsiders (Jensen 1986, Berger et al 1997 and Abor 1997), while Weir and Laing (2001) and
Pinteris (2002) find no such relationship in terms of accounting profit or firm value. Also,
Forsberg (1989) find no relationship between the proportion of outside directors and various
performance measures. In the same vein, Hermalin and Weisbach (1991) and Bhagat and
Black (2002) find no correlation between the degree of board independence and four
measures of firm performance.

CEO duality
Several studies have examined the separation of CEO and chairman of the board,
positing that agency problems are higher when the same person occupies the two positions.
Using a sample of 452 firms in the annual Forbes Magazine rankings of the 500 largest USA
public firms between 1984 and 1991, Yermack (1996) shows that firms are more valuable
when the CEO and the chairman of the board positions are occupied by different persons.
Sanda et al (2003) found a positive relationship between separate CEO and chairman
positions and firm’s performance while Abor (2007) concluded that there is a positive
correlation between CEO duality7 and capital structure and Rechner and Dalton (1991) found
that firms with CEO duality performed better while.

Audit Committee Independency

The audit committee also plays an important role in the improvement of firm value by
implementing corporate governance principles. The principles of corporate governance
suggest that the audit committee should work independently and perform their duties with
professional care. The audit committee monitors mechanisms that improve quality of
7
CEO duality; when the positions of Chairman and CEO are held by the same person.

14

information flows between shareholders and managers (Rouf, 2011, p.240), which in turn,
help to minimize agency problems. Most empirical works like Ho 2005 have revealed
positive findings whilst some, like Brown and Caylor (2005), have concluded that the
significance of the relationship lies between audit quality and dividend yield and not with
operating performance. Klein (2002) reports a negative correlation between earnings
management and audit committee independence. Anderson, Mansi and Reeb (2004) find that
entirely independent audit committees have lower debt financing costs.

Disclosure of Stakeholders’ interests; Corporate Social Responsibility
(CSR)

Corporate social responsibility is the commitment of business to contribute to
sustainable economic, development, working with employees, their families, the local
community and society at large to improve their quality of life. Therefore, ethical deeds
would send the correct signal to the different stakeholders and impact on performance. For
example, Ho (2005) illustrated in his survey that firms perform better than without theses
fundamentals In a study by Hackston and Milne (1999), it was seen that New Zealand
companies make most social disclosures on human resources, with environment and
community themes also receiving significant attention.

.

In summary, the empirical studies reveal mixed views about the relationship between
governance and performances. Unfortunately, generalizability of such findings may not
extend across national boundaries due to different regulatory and economic environments,
cultural differences, the size of capital markets and the effectiveness of governance
mechanisms.

15

Chapter 3; Research Methodology

This chapter contains a description of the methodology of the study which covers
Population, Sample, List of variables, Data collection, model specification and the proxies
that were used. Panel data methodology was adopted because it combined time series and
cross sectional data. The method of analysis is multiple regression, fixed and random effects
model.

3.1 Sample/ Research Design
The data used for this study were derived from the audited financial statements of the
firms listed on the official market for the year 2007-2011. The sample of the firms were
selected using the combination of non- probability sampling technique (firms with the
required information; were initially selected) and stratified random technique (firms were
then selected based on their sectorial classification) while some sectors were excluded 8. A
total of 39 firms (see Appendix A) were finally used as sample as shown in the table below.

SECTOR Number of firms
Banks & Insurance and other finance 7
Commerce 5
Industry 8
Investments 12
Leisure & Hotels 4
Sugar 2
Transport 1
Total: 39
Table 1: Number of firms in the sample

8
The following sectors were excluded from the sample because of their complicated regulations; debt, foreign,
global and specialised firms, specialised debt securities , global business companies.

16

3.2 Independent and Controlling Variables
To increase the confidence of the results, there are set of controls variables which are
included in the regressions. The study expects firm size may have a negative effect if size is
correlated with the exhaustion of growth opportunities, but may contrarily have a positive
impact whenever size is correlated with more diversification, greater economies of scale and
scope, more professionalized management, and less severe financial constraints. Sales growth
is a proxy for the product demand faced by the firm and its productivity.

Therefore to account for these, additional independent variables were added other
than corporate governance elements, to the model as shown in the table below.

Independent Variables Abbreviations Description
Ownership structure OS Shares held by board of directors/ Total no. of
shares outstanding, following Eric Sevrin
(2001),
Ownership concentration OC Shares owned by top10 shareholders/ Total no. of
shares following Lin Chen et. al (2008)

Board Size BS Ln of total No. of Board members

Board Independence BI NED/ Total No. of Directors
in Board) being in line with Kee et al (2003), Lin
Chen (2008)
Audit Committee ACI Non-Executive directors in Audit committee/
Independence Total No. of Directors in Audit Committee)
following Forker’s (1992)
CEO Duality CEOD Whether CEO and Chairman is the same person.

Sales Growth SG Current sales minus previous years sale/
previous years sale following signalling theory
Return on Equity ROE Net Profit/ Shares Holders equity.

Size of the firm Size Ln of total Assets following Scott and Martin
(1975)

Table 2 List of independent variables

17

3.3 Sources of data
To be able undertake our research, we must collect the maximum data available, that
is qualitative and quantitative data. We cannot concentrate on only one sort of data. First of
all I derived a list of all companies since the population of listed companies is small; most of
the firms were selected apart from the debt and GBC sector because of their specific
regulations. Also, eliminate all utility and affiliates of foreign firms.

Data on required variables is collected through primary and secondary sources. Data
were collected through self-administrated survey, mail survey, interviews and annual reports
(2007-2011). The Stock Exchange of Mauritius website and individual companies’ website
were extremely useful.

3.4 Proxies used
Variable Abbr. Description
Capital structure measure

Leverage ( Market value) LevMV Total debt/(Total debt+ MV of shareholder’s
equity)

Firm Performance measure
Return on asset ROA Profit after tax/ total asset

Tobin’s Q Q Total market value of firm/ total asset value

Where Total market value of firm= equity market value +
book value of debt
Since market value of debt is not publish.
Altman Z-score AltZ See Appendix B

Table 3: Dependent variables

18

Leverage will be used as a proxy for capital structure. ROA will be used as an
indicator for profitability and efficiency. Tobin’s Q selection as a ratio to measure firm value,
as employed by previous studies mentioned in literature part. Altman Z Score was used as a
proxy for financial health of the company. It is an improvement of the debt ratio in the sense
that it takes into account the current liquidity position held by the company. This score
calculated by five ratios:

1. Liquidity on total assets

2. Sales to total assets

3. Equity to debt

4. Working capital to total assets

5. Retained earnings to total assets

Altman Z Score is the summation of these ratios multiplied by a predetermined
weight factor. Score above 2.99 are considered to be financially sound, while those scoring
below 1.81 are in fiscal danger, maybe even heading toward bankruptcy. Therefore, scores
within the range 1.81-2.99 indicate potential trouble (See Appendix B for more details).

3.5 Model Specification
Given well-organized panel data, panel data models are definitely attractive and
appealing since they provide ways of dealing with heterogeneity and examine fixed and/or
random effects in the longitudinal data. Our model is a micro panel (N is large and T is less
or equal to 5 years). However, panel data modelling is not as easy as it sounds. We should not
rush in just choosing fixed effect model or random effect model. Carelessness could lead to
wrong interpretation and inappropriate modelling.

In our empirical panel data, we are concerned about choosing between three alternative
regressions. This choice is between Ordinary Least Squares method, fixed effects (or within,
or least squares dummy variables) estimation and random effects (or feasible generalized
least squares) estimation. A series of tests are carried to test for fixed and random effects in

19

the model and appropriate model will then be fitted. The F-test for fixed effects, Breusch-
Pagan LM Test for Random Effects and Hausman Test for Comparing Fixed and Random
Effects.

The Multiple OLS Regression
A multiple OLS regression is concerned with the relationship between a dependent
variable and a series of independent variables. The multiple regression allows the analyst to
control for the multiple factors that simultaneously affect a dependent variable. The following
represents the relationships in our model

= + + + + + + + + +
+ eit ,

where Y is the dependent variable and the assumptions of linearity, reliability of
measurement, homoscedasticity, and normality and no autocorrelation (Gauss-Markov
Theorem).

Fixed versus Random Effects

The distinction lies in how the parameter estimate of the dummy variable is treated. It
is a part of the intercept in a fixed effect model while an error component in a random effect
model. Slopes remain the same across group or time period in either fixed or random effect
model. The functional forms of one-way fixed and random effect models are

Fixed effect model: y ( ui ) X it' vit

Random effect model: y X it ui vit ,

where i u is a fixed or random effect specific to individual (group) or time period that
is not included in the regression.

20

F-test for Fixed Effects

In a regression of Y X it , the null hypothesis is that all dummy
parameters except for one for the dropped are all zero, :

H0: … .

The alternative hypothesis is that at least one dummy parameter is not zero. This
hypothesis is tested by an F test, which is based on loss of goodness-of-fit. This test contrasts
LSDV (robust model) with the pooled OLS (efficient model) and examines the extent that the
goodness-of-fit measures (SSE or R2) changed. If the null hypothesis is rejected (at least one
group/time specific intercept ui is not zero), you may conclude that there is a significant fixed
effect or significant increase in goodness-of-fit in the fixed effect model; therefore, the fixed
effect model is better than the pooled OLS.

Breusch-Pagan LM Test for Random Effects
Breusch and Pagan’s (1980) Lagrange multiplier (LM) test examines if individual (or
time) specific variance components are zero,

H0:

The LM statistic follows the chi-squared distribution with one degree of freedom. If the
null hypothesis is rejected, you can conclude that there is a significant random effect in the panel
data, and that the random effect model is able to deal with heterogeneity better than does the
pooled OLS.

Hausman Test for Comparing Fixed and Random Effects
How do we know which effect (fixed effect or random effect) is more relevant and
significant in the panel data? The Hausman specification test compares fixed and random effect
models under the null hypothesis that individual effects are uncorrelated with any regressor in the
model. Hausman test examines if “the random effects estimate is insignificantly different from
the unbiased fixed effect estimate” (Kennedy, 2008). If the null hypothesis of no correlation is
rejected, you may conclude that individual effects ui are significantly correlated with at least one
independent variable in the model and thus the fixed effect model is preferred.

21

Chapter 4; Data Analysis and Results

Note: Raw data used in this study can be found in Appendix C.

4.1 Descriptive statistics

Variable Mean Std. Min Max Percentiles Skewness Kurtosis
Dev.
50% 75%
os 0.09 0.14 0 0.69 0.2444 0.1167 2.5561 9.5855
oc 0.61 0.221 0.12 0.9 0.6979 0.7855 6.8495 47.9520
bs* 10.381 0.190 7.029 15.029 11.0000 12.0000 -0.3006 2.4542
bi 0.78 0.11 0.29 0.93 0.8182 0.8462 -2.0272 9.1234
aci 0.94 0.11 0.67 1 1 1 -1.6247 3.9341
ceod 1 0 0 1 1 1 -5.5110 31.3643
csr 14.51 1.87 9.25 18.56 14.2393 15.9909 -0.1949 2.7429
sg 0.2 1.09 -1 10.56 0.1029 0.1915 -1.1589 9.0235
roe 0.15 0.23 -0.11 1.93 0.0892 0.1789 5.5249 37.5252
size 22.52 1.79 16.29 26.24 22.7659 23.4938 -0.7716 4.5833

levmv 0.24 0.24 0 0.92 0.1763 0.3425 1.3031 4.1188
roa 0.076 0.085 -0.137 0.53 0.0618 0.0896 2.7724 14.1578
Tobin’s Q 0.923 1.016 0.059 7.113 0.6589 0.9891 4.4896 25.8754
altz 3.824 5.928 0.116 33.113 1.9089 3.6978 3.4560 15.5165

*bs was returned to exponential form, i.e. absolute values
Source: STATA output

Table 4: Descriptive statistics

Table 4 shows number of observations, mean, median, standard deviation, maximum,
and minimum as well the skewness which will give us an idea of how the distribution behave.
The mean shows the average figure of the variable for the data set. The standard deviation
(sd) is an indication of how the data deviates around the mean. It is a measure of dispersion

22

(variability). The higher the figure, the higher it deviates/scatters around the mean value and
is an indication of margin of errors. The skewness measures the degree and direction of
asymmetry, whether the mean is less or greater than the median is the indication. If mean is
less than the median, then the distribution is said to be negatively skewed and in the other
hand, if mean is greater than median, the distribution is said to be positively skewed. A
normal distribution has a skweness of 0. Kurtosis indicates how peak or pointed the
distribution is. Bell curve (mesocurtic , are considered to be perfect and has a kurtosis of 3 ).
Heavy tailed distribution, with many outliers, will have a kurtosis greater than 3 (Flat -
platykurtic). Light tailed distributions, less outliers will have kurtosis less than 3 (Sharp –
leptokurtic). The figure 3 serves as a benchmark.

We would focus more on the governance variables and from reference to the table
above, board directors on average own only 9% which is significantly good and in line with
agency theory, as principals have minority interest aligning maximising shareholders’ wealth.
However, this figure does not reflect the whole sample. Some directors do not even have
interest in company, or are relatively low. Whilst, some were originally private companies
before listing, obviously have board members holding significant interest in the company. For
example directors of Gamma Civic Ltd owned more than 50% of the outstanding shares. The
sd is 0.14 meaning that values varies 14% around the mean and margin of errors is low. As
it can be seen in the percentile range, the median (24.4%) is greater than the mean (9%), the
distribution is concentrated to the right and the kurtosis of 9.5 shows that the distribution is
heavily tailed and thus assumes a flat distribution.

Ownership concentration is very high. The mean is 61%, i.e. top 10 shareholders
holds on average 61% of the company’s outstanding shares. Margin of error is also low. In
some companies, concentration is even 90%. 50% of companies in the sample have
ownership concentration of 69.79 or more. The skewness is significantly positive and
therefore the data is significantly concentrated to the right and is heavily tailed. Board size
averages to 10 members. Lipton and Lorsch (1992) suggest an optimal board size between seven
and nine directors 75% of companies have 12 or more directors in the board. The distribution
is however close to normal (skewness of -0.3 and kurtosis < 3). Board independence also is
an important variable. The figures show that board are majorly consisted of non-executives
(and/ or independent directors). 75% of companies consist of mainly non-executive s (and/or
independent directors). This is in line with the RCCG which specifies at least two two
independent and two executive directors in the board. Audit committees have high

23

independency level. This is a major requirement of the Corporate Governance Code of
Mauritius. Companies are therefore tending to adopt the code practices. This is the same for
CEO duality where every company separated the powers of the CEO and the Chairperson and
are occupied by two different persons. Again, this is in line with the code and while
collecting data, I can further conclude that most of all CEO are non-executives. The CSR
variable cannot be described since (i) it is in exponential form and (ii) we are more concerned
on its impact than CSR itself since some contributes massively and even have foundations
while some contribute a relatively low amount either they are subsidiaries of the foundation
or otherwise.

Firms on average have a debt ratio of 24% which is relatively low. Firms are low
geared. Variability is also low; low sd, 75% have debt/equity of at least 34.25%, skewness is
positive and low and also kurtosis is 4.12. However, some firms are highly geared (92% as
maximum). Return on asset averages to 7.6%. sd is less than 10%. While some companies
reported negative return. Tobin’s Q mean is 92.3% which means 92.3% of total assets
contribute to the total market value of firm. This means that total assets are wisely employed.
Again, the distribution is heavily tailed to the right.

Altman Z-score on average is 3.824 (> 3 indicating high bankruptcy). This data alone
is not reliable since the sd is 598.28%! This is due to the presence of the inclusion of different
industries in the same sample. Every company need not to have same ratios which are
weighted in the formula. Some companies, especially those in banking sector had negative
working capital/ total assets ratio since liabilities are greater than assets. Deposits from
customers are liabilities! The distribution is heavily tailed to the right and is therefore
affected by outliers.

24

4.2 Corporate Governance and capital structure
A very laborious literature is found on the debate about the link between capital
structure and corporate governance which is at heart of agency theory. All the corporate
variables and controlling variables were analysed on dependent variable, which is debt to
total of debt and market equity. The following are the variables used in this section:

Dependent variable (Y): levmv

Independent variables (X): os, oc, bs , bi, aci, ceod, csr, sg, roe, size

4.2.1 Correlation
The Person correlation was performed to measure the degree of linear relationship
between the variables. It shows how close two variables are assuming that it is linear and is a
measure of how tightly cluster data are about the correlation line. Ranging from -1 to +1,
negative coefficient indicates a negative relationship. The table below present the correlations
coefficients and its significance in parentheses.

25

levmv os oc bs bi aci ceod csr sg roe size
os -0.041 1
(0.683)
oc -0.137 -0.044 1
(0.175) (0.667)
bs 0.156 -0.475* 0.146 1
(0.121) (0) (0.148)
bi 0.168** -0.267** 0.075 0.338* 1
(0.096) (0.007) (0.456) (0.001)
aci -0.138 -0.018 0.068 0.107 0.348* 1
(0.171) (0.856) (0.503) (0.291) (0)
ceod -0.089 -0.446* 0.028 0.1762** 0.023 0.044 1
(0.377) (0) (0.784) (0.08) (0.818) (0.665)
csr -0.061 -0.075 0.157 0.4164* 0.046 0.009 -0.059 1
(0.55) (0.462) (0.118) (0) (0.653) (0.931) (0.559)

sg 0.126 0.041 0.128 -0.159 -0.230** -0.073 -0.021 0.057 1
(0.211) (0.685) (0.204) (0.115) (0.022) (0.47) (0.832) (0.573)
roe -0.025 -0.035 0.4109* 0.137 0.036 0.104 0.037 0.141 0.022 1
(0.807) (0.732) (0) (0.173) (0.719) (0.305) (0.717) (0.161) (0.827)
size 0.276* -0.180** -0.358* 0.235** 0.001 -0.016 0.048 0.438* -0.015 -0.191** 1
(0.006) (0.073) (0) (0.019) (0.995) (0.875) (0.638) (0) (0.884) (0.057)

Table 5: Correlation capital structure and corporate governance

26

From table 5, using the Pearson correlation, levmv is positively correlated to board
independence and is significant at the 0.01significance level and firm size also is positive and
significant at the 0.05 level. Board shareholding, ownership concentration, and audit
committee are negatively correlated. This means that, for instance, when board shareholding
increases, decisions about debt tend to be less favourable and prefer equity finance. This is a
rational behaviour as they fear any risk of bankruptcy being heavily debt. They tend to avoid
debt finance. This is consistent with Jensen (1986), Berger et al. (1997) and Abor (1997).

Board size is positively correlated to leverage. Thus This is consistent with Wen et
al.(2002) and Abor (2007). Berger et al. (1997) on the other hand, found that large board size
results in low leverage levels. Furthermore, CEOs also seem to avoid leverage but the value
is not significant.

A thorough study of the relationship between dependent variables reveals that they are
not, at most perfectly correlated. Correlation coefficients ranges from –0.5 to +0.5 .Testing
for correlation is important as this may lead to high coefficient standard errors and low t-
statistics making it harder to reject the null hypothesis. However, as we shall consider in the
next section while doing the OLS estimation (after being tested), multicollinearity presence
did not violate the estimations. OLS estimates are still unbiased and BLUE (Best Linear
Unbiased Estimators)

4.2.2 Regression results and discussion

Before beginning with analysis of the study, we have first to ascertain which
estimation model is appropriate and fits the data the best. The model with best with better
2
goodness-of-fit measures (like R ,test for heterosdasticity and test for autocorrelation),
parameter estimates with their standard errors, and test results will be selected. This will then
be coupled with Hausman test for fixed versus random effects, F-tests to test for any fixed
effects, Breusch and Pagan Lagrangian Multiplier test for any random effects.

27

Now we start our analysis. I first use Hausman test. The Prob>chi2 = 0.1296, and
thus the test provides decisive evidence that the H0 is wrong at the 0.05 level. We therefore
reject the null hypothesis at the 0.1 level and thus the random model is preferred. In
connection, we run the BPLM test for random effects. The chibar2(01) = 46.10 and
Prob > chibar2 = 0.0000, we reject Ho at the 0.05 level and thus the random effects is again
favoured against the OLS. However, we also run the F-test to validate the non-presence of
fixed effects. The xtreg command renders Prob > F = 0.0000 which is less than the 0.05. We
therefore reject the null hypothesis at the 0.05 level as there is sufficient evidence; significant
increase in goodness of fit in the fixed effect. We can still not conclude on which estimation
suits the data best. We shall now compute the three estimation models and observed the
goodness of fit.

The table below summarises estimation results from OLS, fixed effects (LSDV) and
random effects (re theta and GLS). It appears that the random effect model does not suit the
estimation. The goodness of fit values is insignificant and also no significant coefficients are
produced. The fixed effect model renders R2 of 77.16% but produces no sufficient
information about the link between the variables. The OLS seems appropriate. Table 6 shows
the statistics when different estimation model applied.

Variable OLS Fixed effects Random effects
os 0.23455 0.14386 0.04819
(0.1381) (0.1955) (0.1536)
[1.699] [0.7358] [0.3138]
oc -0.00093 0.00019 0.00078
(0.00111) (0.00224) (0.00086)
[-0.8424] [0.08605] [0.9049]
bs 0.3355 0.26105 0.27873
(0.1746) (0.1558) (0.308)
[1.922] [1.676] [0.9051]
bi .57292** 0.30406 0.21723
(0.1763) (0.1966) (0.1317)
[3.249] [1.547] [1.649]
aci -0.49383 -.37182* -0.30666
(0.2559) (0.1612) (0.2329)
[-1.93] [-2.306] [-1.316]
ceod -.14908* -0.13009 -0.11539

28

(0.06941) (0.1044) (0.07418)
[-2.148] [-1.246] [-1.555]
csr -.0483*** -.02466* -0.01933
(0.01416) (0.0119) (0.01287)
[-3.411] [-2.072] [-1.502]
sg .20684** 0.09055 0.06775
(0.06155) (0.06678) (0.04732)
[3.361] [1.356] [1.432]
Roe .10648* 0.03331 0.00821
(0.04614) (0.07959) (0.06782)
[2.308] [0.4185] [0.1211]
Size .05518*** 0.03168 0.00621
(0.01287) (0.01643) (0.01217)
[4.286] [1.928] [0.5097]
_cons -.976* -0.52045 -0.31626
(0.4408) (0.5048) (0.8541)
[-2.214] [-1.031] [-0.3703]
F-test 2.98 6.46 13.02
(model)
p-value 0.0028* 0* 0.2226
DF 99 94 94
2
R 0.2506 0.7716 0.3268
SSE 4.11087 1.25266661 0.13882289
(SRMSE)
Root /mse 0.21492 0.13882
σu 0.170409
θ 0.6577
Effect test 6.18* 5.74
N 100 100 100
Coefficient/ standard error/t-statistic
* p<0.05; ** p<0.01; *** p<0.001
Significant coefficients in bold
STATA Output
Table 6: Regression results, capital structure and corporate governance

29

[ R2 = 0.2936; Adj R2=0.1664, SSE= 4.11, F=2.98* , mse= 0.21492]
Regression equation: levmv= 0.235 OS – 0.001 OC+0.336 BS+0.573 BI-0.494 ACI-0.149 CEOD-0.048 CSR+0.207 SG+0.107 ROE+0.55 SIZE- 0.976
Special Wald Test: F( 10, 89) = 3.70, Prob > F = 0.0004

Unstandardised coefficients standardised Collinearity statistics
coefficients

levmv Coef. Robust Std. Beta t P>t [95% Conf. VIF tolerance
Err. Interval]

os 0.2345 0.1381 0.1441 1.7 0.093 -0.1403 0.6094 1.69 0.5911
oc -0.0009 0.0011 -0.033 -0.84 0.402 -0.0072 0.0053 1.54 0.6511
bs 0.3355 0.1746 0.2663 1.92 0.058 0.0381 0.6329 1.78 0.5623
bi 0.5729** 0.1763 0.2697 3.25 0.002 0.1300 1.0159 1.39 0.7206
aci -0.4938 0.2559 -0.2342 -1.93 0.057 -0.8970 -0.0907 1.17 0.8571
ceod -0.1491* 0.0694 -0.1086 -2.15 0.034 -0.4252 0.1271 1.29 0.7748
csr -0.0483*** 0.0142 -0.3844 -3.41 0.001 -0.0774 -0.0192 1.71 0.5858
sg 0.2068** 0.0615 0.235 3.36 0.001 0.0423 0.3714 1.12 0.8966
roe 0.1065* 0.0461 0.105 2.31 0.023 -0.0940 0.3069 1.25 0.8018
size 0.0552*** 0.0129 0.4204 4.29 0 0.0247 0.0856 1.72 0.5831
_cons -0.9760* 0.4408 . -2.21 0.029 -1.8797 -0.0723
Mean VIF=1.46
* p<0.05; ** p<0.01; *** p<0.001 level of significance
Table 7 Multiple regression result: leverage and corporate governance

30

IM test for Ho: homoscedasticity; Chi(2)=87.20, p=0.0534,
Likelihood-ratio test : sig= 0.03
Durbin-Watson d-statistic( 11, 100) = 1.359768 9

The Special Wald test was first performed as to test whether at least one of the
governance variables is significant at the 0.05 level. The p-value is 0.0004 which is lower
than the 5% level of alpha. Hence, we can reject the null and at least some independent
variables are significant. This reinforced significant values if only looking at the F-test. The
high p-value of the IM test for heteroskedasticity shows that heteroskedasticity was a
problem at the 5% level and the robustness function was used to capture any presence since
the no-one knows the true value of p. A test for autocorrelation was also performed,
represented by the Durbin-Watson test. The d-statistic is 1.36, and stands in the zone of
indecision for possible autocorrelation. As a rule of thumb, if a VIF is in excess of 9 or a
tolerance (1/VIF) is .05 or less, there might be a problem of multicollinearity (Lazaridis and
Tryfonidis, 2006). We therefore assume that the OLS assumptions are not violated. The
likelihood–ratio test is significant at the 0.05 level, thus there is an evidence of association
between leverage and the corporate variables.

From the table 8, the R-square is 29.36%. This means that 29.36% of the variance in
leverage is explained by the independent governance variables. The higher the figure, the
better the variance is explained. The model being significant but R 2 small, it implies that
observed values are widely scatter around the regression line. The F-statistic of the OLS
estimation is 2.98 and therefore significant at the 0.05 level. This means that the model
statistically reliable and is not spurious. The RMSE is the square root of the variance of the
residuals. RMSE is an absolute measure of fit. From Table 7, 21.5% of the observed data
points are close to the model’s predicted value. The beta value of is a measure of how
strongly each independent variable influences leverage. The beta is measured in units of
standard deviation. For example, a beta value of 0.1441 for ownership structure indicates that
a change of one standard deviation in the leverage will result in a change of 0.1441 standard
deviations in the ownership structure variable. Thus, the higher the beta value the greater the
impact of the independent variables on leverage. Having analysed goodness of fit, we are
now going to test our previous hypotheses introduced in chapter 1.

9
From Durbin Watson significance table, dU=1.314, dL=1.79

31

H1: There is a significant relationship between ownership structure and firms' capital
structure

Board ownership is positively related to leverage. The standard deviation is 0.1381, i.e.
observed values differ by 13.8% around the mean value. However, no significant relationship
was found. Agrawal and Mandelker(1987) also found a positive relationship.

H2: There is a significant relationship between ownership concentration and firms' capital
structure

Ownership concentration is negatively related to leverage. No significant relationship was
found.

H3: There is a significant relationship between board size and firms' capital structure

Even board size is positively related to leverage. Despite not being significant, this result is
consistent with Wen et al.(2002) and Abor(2007). Also big boards have larger debt in their
capital as argued by Jensen (1986). Larger board size translates into strong pressure from the
corporate board to make managers pursue lower leverage or debt ratio rather than have larger
boards.

H4: There is a significant relationship between board independence and firms' capital
structure.

There is a positive and significant relationship (at the 0.01 level) between board
independence and leverage. This means that executive board members prefer low leverage
and therefore use internal finance first. Since they have interest on the company, they will not
want to take huge risks in leverages. This is refuting Wen et al. (2002) where a significant
negative relationship was found but is consistent with Berger et al. (1997). The coefficient
0.573 means that for every one % increase in board independence, i.e. a non-executive
joining in, leverage is expected to increase by 0.573 %, assuming ceteris paribus.

32

H5: There is a significant relationship between independent audit committee and firms'
capital structure

A negative relationship exists between audit and leverage. Besides, it is not significant.

H6: There is a significant relationship between CEO duality and firms' capital structure

CEO duality has a negative and significant relationship at the 0.05 level. This means that so
long as CEO and Chairman Position are occupied by the different persons, leverage will
decrease. This might reveal that CEO and Chairman decisions on leverages do not tally.

H7: There is a significant relationship between social responsibility and firms' capital
structure

As the companies contribute more towards social responsibility, leverages tend to decrease.
The study shows a negative relationship and this is statistically significant at the 0.001
significance level. This might possibly means that as company contributes more to CSR,
sales revenue increases and building internal finance in the form of retained earnings. This is
further backed by a positive relationship between sales growth and leverage. This might
explain the pecking order theory.

The study also reveals that profitability (roe) is also significantly related to leverage (at the
0.05 level) and this is consistent with pecking order hypothesis. For every one % increase in
profitability, leverage is expected to increase by 0.106%. In addition, the study reports that
other determinants that do not proxy for control rights are consistent with previous findings.
Firms that are larger have more tangible assets and are also more leveraged.

In this vein, the submission of this study is that the issue of capital structure is more of
an empirical issue than theoretical proposition since it is different from countries to countries,
perhaps depending on the level of development. However, the limitation of this study is that
we cannot conclude if this assertion also holds across different sectors in the same country or
economy.

33

4.3 Corporate Governance and Firm Performance
4.3.1 Correlation

ROA Q AltZ
os 0.008 -0.025 -0.002
(0.938) (0.803) (0.987)
oc 0.5796* 0.4551* 0.5589*
(0.000) (0.000) (0.000)
bs 0.098 0.2295* 0.130
(0.334) (0.022) (0.208)
bi -0.034 0.138 0.120
(0.735) (0.170) (0.244)
aci 0.166 0.054 0.121
(0.099) (0.597) (0.240)
ceod 0.027 0.089 0.058
(0.787) (0.377) (0.573)
csr -0.028 0.054 -0.024
(0.786) (0.591) (0.817)
sg -0.086 -0.020 -0.039
(0.394) (0.845) (0.710)
roe 0.4617* 0.3874*
(0.000) (0.000)
size -0.470* -0.4523* -0.6171*
(0.000) (0.000) (0.000)
Correlation coefficient and significance value given in ( ).
* p<0.05; level of significance
Table 8 Correlation: Corporate governance and performance

In the table, variables which are statistically significant at respective significance level are
shown in bold. Board ownership, large block shareholders, board size, corporate social
responsibility and sales growth are negatively correlated. Only board independence, ceod,
return on equity and size is positively related. Inclusion of outside directors in the board
lowers return on asset but however is positively related to npm, Tobin’s Q and altman Z
Score. This is consistent with Brown and Caylor (2006) who found that firms with more

34

independent directors performed well while Agrawal and Knoeber (1996) found an opposite
view. As from the table, it is more likely to be positive related, to three dependent variables.
CEO duality is positively correlated to all performance proxies. This is consistent Sanda et al.
(2003) who found a positive relationship between separate CEO and Chairman positions and
firm performance. CSR seems to be relatively uncorrelated. Size is negatively related to most
proxies. As expected, an increase in assets does not necessarily increase performance.
Increase in size may be attributed to other reasons like manufacturing process. However, it is
statistically significant at the 0.01 level.

4.3.2 Regression results and discussion

The Fixed effect model (Least Square Dummy Variable) was used for return on asset
while Tobin’s Q and Altman Z-score used OLS multiple regression model coupled with
appropriate tests. Regression results can be found in Appendix E.

ROA as dependent

roa Coef. Std. Err. t P>t

os 0.024 0.096 0.25 0.801
oc 0.002* 0.001 2.55 0.013
bs 0.118 0.077 1.53 0.13
bi -0.115 0.078 -1.47 0.147
aci 0.001 0.060 0.02 0.987
ceod -0.020 0.039 -0.51 0.611
csr -0.005 0.005 -1.09 0.279
sg -0.018 0.025 -0.73 0.468
size 0.018* 0.008 2.25 0.028
_cons -0.224 0.262 -0.85 0.396
F test (model) 5.53, p-value 0.0000, Obs.=100, R2 =0.7337, SSE 0.1913
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity: chi2(1) = 68.27,Prob > chi2 = 0.0000
Durbin-Watson d-statistic( 10, 100) = 1.79
* p<0.05; ** p<0.01; *** p<0.001 level of significance

Table 9 Regression results: ROA and governance (Fixed Effect model)

35

BP test shows that variance are constant, i.e heteroskedasticity was not a problem (p-
value< 0.05 at the 5%level). The d statistics is 1.7910 and therefore in in the vicinity of 2,
indicating that autocorrelation was not at least present. This reinforces the p-value of the
fixed effect model and therefore will produce unbiased estimates. The core assumptions of
the panel data model were not violated.

The fixed effect model for return on asset shows a negative relationship between
board equity, board independence, CEO duality CSR and sales growth. Ownership
concentration, board size, audit and size have positive relationship. The p-value for the model
is 0.0000 which therefore reveals that the model fits the observed data at the 0.05 level. R 2 is
high at 0.7337. 73.37% variation in roa is explained by independent variables. This low p-
value and high R2 means that the observed value are closely scattered around the regression
line. The sum of squares, i.e. residuals is very low. This further explained the goodness fit of
the model. The F-test for fixed effect test is 2.50 (p-value 0.0018) and therefore we reject the
null hypothesis that means of dummy variables are zero as the 0.05 level and hence use fixed
effects as there are significant statistical evidence. The regression output revealed that
ownership concentration is positively and statistically significant (at the 0.001) level with roa.
As more large shareholders invest massively, the firm successfully grow and profitability
increases. Large shareholders are often institutions and other companies. This adds more
pressure to the board to perform well.

10
d < 2 for positive autocorrelation of the residuals, d >2 for negative autocorrelation and d~2 for zero
correlation

36

Tobin’s Q as dependent variable
Unstandardised standardised Collinearity
coefficients coefficients statistics

Q Coef. Robust Beta t P>t VIF tolerance
Std. Err.
os 0.692* 0.304 0.098 2.27 0.025 0.025 0.591
oc 0.016 0.035 0.133 0.47 0.642 0.642 0.651
bs 1.328* 0.659 0.244 2.02 0.047 0.047 0.562
bi 0.643 0.465 0.07 1.38 0.17 0.17 0.721
aci -0.416 0.482 -0.046 -0.86 0.39 0.39 0.857
ceod 0.611** 0.222 0.103 2.75 0.007 0.007 0.775
csr 0.052 0.031 0.096 1.68 0.096 0.096 0.586
sg -0.02 0.177 -0.005 -0.11 0.91 0.91 0.897
roe 1.217 1.123 0.278 1.08 0.281 0.281 0.802
size -0.249* 0.110 -0.439 -2.27 0.026 0.026 0.583
_cons 1.688 1.911 . 0.88 0.38 0.38
F test (model)=7.67, p-value= 0.0000, Obs.=100, R2= 0.4628, Adj R2= 0.4024, SSE= 54.866
Mean, VIF=1.46
White's test: chi2=111.58 p-value= 0.0007
Likelihood-ratio test : LR chi2(1) = 7.91, Prob > chi2 = 0.0049
Durbin-Watson d-statistic( 11, 100) = 1.586145

Table 10 Regression result for Tobin's Q and governance ( OLS)

OLS was deemed to be appropriate for Tobin’s Q dependent variable. Goodness of fit
measures is significmant. The likelihood ratio test shows the evidence of linear association
between Q and governance variables. Ownership structure is positively and significantly
related to firm’s value. Jensen and Meckling (1976) showed that when managerial ownership
falls, the agency costs increase, since anagers can benefit from the consumption of non-
pecuniary benefits. Managers here are however motivated by incentives as they will benefit
from a larger proportion of the benefits associated with their effort. This ultimately increases
firm value. Director’s remuneration and share schemes should be considered. Also, the study

37

revealed that board size is positively related to firm value and is statistically significant at
0.05 level. The standard error is more than 50%. But accordingly, it means that as more one
more director is appointed in the board, firm value will increase by 1.3%. I deduced that the
board skills/ qualifications and experiences are therefore important. The addition brings on
expertise and the performance and firm value increases.

Furthermore, there exist a positive and significant relationship between CEO duality
and firm value. The positive relation between the proportion of outside directors and the
likelihood that an outside director is appointed as CEO and such an appointment benefits
shareholders. This is consistent with Rouf (2011) findings.

Size on the other hand is negatively related to firm value. The coefficient is
statistically significant at the 0.001 level and has good parameter estimates sd. An increase in
size does not increase firm value. This can simply be demonstrated in the formula of Tobin’s
Q, where total asset is in the denominator. Thus increase in size, measured by the natural
logarithm of total asset.

38

Impact of Corporate Governance on Leverage and Firm performance: Mauritius

Impact of Corporate Governance on Leverage and Firm performance: Mauritius

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