The effect of corporate governance and shareholder monitoring mechanisms on cost of capital: empirical evidence from Malaysian listed firms from 2003 to 2007

Abstract

Although corporate governance issues emerged with the birth of corporations, they were largely unheard of in Malaysia until the Asian financial crisis in 1997-1998. The financial crisis basically serves as the impetus for corporate governance reforms in Malaysia. The government responded to an urgent call for corporate reforms and commissioned a committee to examine the issues of corporate governance. As a result, the Malaysian Code on Corporate Governance was introduced in 2000 to serve as a benchmark for firms to follow. Much has been debated about the state of corporate governance in Malaysian listed firms but evidence to date does not present adequate empirical case that corporate governance and shareholder monitoring mechanisms lower firms’ cost of capital. Prior studies in Malaysia mainly measure value creation from the perspectives of accounting and market performances. There is an emerging brand of idea that firm value can also be viewed from the perspective of the ability of the firm to benefit from a reduced cost of capital as a result of a robust corporate governance. This study investigates the effect of corporate governance and shareholder monitoring mechanisms on firms’ cost of capital between 2003 and 2007 from the theoretical perspectives of debt agency cost and the traditional manager-shareholder agency cost. Quality of firm corporate governance is measured using a comprehensive corporate governance index, which is developed for this study. Shareholder monitoring mechanisms are represented by ownership concentration, family, insider and government shareholdings. Using panel data regression technique, this study finds that overall corporate governance and shareholder monitoring mechanisms have a reducing effect on both costs of equity and debt. Both equity holders and debt issuers are willing to accept lower risk premium from firms that have robust corporate governance. In terms of shareholder monitoring mechanisms, family ownership reduces cost of equity whilst ownership concentration and insider ownership lower cost of debt.