Capital Structure, Equity Ownership and Corporate Performance: Evidence from Indian Manufacturing Firms (Routledge Studies in Development Economics) 1032503076, 9781032503073

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Capital Structure, Equity Ownership and Corporate Performance

This book provides empirical insights into the relationship between capital and equity-ownership structure of Indian manufacturing companies and their financial performance. It discusses and analyses the basic theories and concepts associated with capital structure, debt financing, levered and unlevered firms, the various forms of ownership, agency problem and its kind and the exploitation of minority owners by the large and largest owners. The study employs a set of the most reliable and suitable econometric estimation techniques to draw meaningful inferences on the Indian manufacturing sector. The novelty of this book lies in three particular aspects: the depth and dimension with which the topic is addressed; the robust empirical evidence that it has produced and the simple and intelligible approach with which it is authored. It communicates the crucial relevance of corporate capital structure and equity-ownership to the moderation of agency relationship and shaping the internal governance mechanism, which ultimately results in increased or decreased operational efficiency and financial performance. It will enable readers to understand whether an increased amount of debt capital would bring about positive results for firms or create an extra burden on the management of their finances, preventing them from taking productive investment decisions due to the threat of liquidation. The book will find an audience among advanced students, scholars and researchers who are interested in understanding the corporate finance practices and governance mechanism of Indian organizations. Krishna Dayal Pandey is an Assistant Professor in the Department of Business Administration, Sidho-Kanho-Birsha University, West Bengal, India. Tarak Nath Sahu is an Associate Professor in the Department of Business Administration, Vidyasagar University, West Bengal, India.

Routledge Studies in Development Economics

179 Development as Swaraj Towards a Sustainable and Equitable Future Sumanas Koulagi 180 The Political Economy of Underdevelopment and Poverty in Nepal Sri Ram Poudyal 181 Post-Pandemic Green Recovery in ASEAN Edited by Farhad Taghizadeh-Hesary, Nisit Panthamit, Naoyuki Yoshino and Han Phoumin 182 Financial Literacy and Ageing in Developing Economies An Indian Experience Kshipra Jain 183 Finance for Sustainable Development in Africa Evolution, Impact and Policy Implications Edited by Nicholas Mbaya Odhiambo, Erasmus Larbi Owusu and Anutechia Simplice Asongu 184 State, Market and Society in an Emerging Economy Development and the Political Economy of Bangladesh Edited by Quamrul Alam, Rizwan Khair and Asif M Shahan 185 Capital Structure, Equity Ownership and Corporate Performance Evidence from Indian Manufacturing Firms Krishna Dayal Pandey and Tarak Nath Sahu

For more information about this series, please visit: www.routledge.com/Routledge-Studies-inDevelopment-Economics/book-series/SE0266

Capital Structure, Equity Ownership and Corporate Performance

Evidence from Indian Manufacturing Firms

Krishna Dayal Pandey and Tarak Nath Sahu

First published 2024 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2024 Krishna Dayal Pandey and Tarak Nath Sahu The right of Krishna Dayal Pandey and Tarak Nath Sahu to be identified as authors of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-032-50307-3 (hbk) ISBN: 978-1-032-50308-0 (pbk) ISBN: 978-1-003-39787-8 (ebk) DOI: 10.4324/9781003397878 Typeset in Times New Roman by codeMantra

Data Availability Statement The data that support the findings of this book are available from the corresponding author, Dr. T.N. Sahu, upon reasonable request.

Contents

List of figures List of tables Preface List of abbreviations 1

Introduction Background of the study 1 Motivation of the study 5 Objectives of the study 6 Scope of this work 7 Chapter outline 7

2

Capital structure and corporate performance: theories and literature Introduction 10 Capital structure theories 10 Concept of vertical agency problem 16 Capital structure and vertical agency problem 17 Corporate performance: a theoretical discussion 17 Capital structure and corporate performance: empirical evidence 21 Concluding remarks 35

3

Ownership structure: the conceptual and empirical framework Ownership structure: the conceptual aspects 40 Ownership structure and vertical agency problem 47 Equity ownership and corporate performance: empirical evidence 47 Concluding remarks 58

ix xi xiii xv 1

10

40

viii Contents 4

Ownership concentration and agency problem Ownership concentration: meaning and significance 62 Ownership concentration and corporate performance: empirical evidence 64 Concluding remarks 71

5

Interaction among capital structure, equity ownership and corporate performance Introduction 76 Methodology 76 Empirical results 88 Concluding remarks 99

6

Ownership concentration and corporate performance: an empirical inquiry Introduction 103 Ownership concentration and corporate performance: empirical findings 103 Largest ownership and corporate performance 104 Discussion of results 106 Concluding remarks 107

7

Conclusion and policy recommendations Introduction 109 Summary of the study 109 Conclusion 112 Recommendations and policy implications 113 Contribution of the study 114 Scope for future research 114

109

Index

117

62

76

103

Figures

6.1 6.2 6.3

Non-linear Effect of Largest_Own on ROE Non-linear Effect of Largest_Own on TQ Non-linear Effect of Largest_Own on MBVR

106 107 107

Tables

5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 5.15 5.16 6.1

Description of the Variables Descriptive Statistics Pair-wise Correlation Matrix and VIF Test of Heteroskedasticity Panel Regression Results (Dependent Variable: ROA) Selection of Appropriate Model from Table 5.5 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: ROA) Panel Regression Results (Dependent Variable: ROE) Selection of Appropriate Model from Table 5.8 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: ROE) Panel Regression Results (Dependent Variable: TQ) Selection of Appropriate Model from Table 5.11 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: TQ) Panel Regression Results (Dependent Variable: MBVR) Selection of Appropriate Model from Table 5.14 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: MBVR) Test of Non-Linearity: Result of One-Step Estimation

81 89 90 91 91 92 93 93 94 94 95 95 95 96 97 97 105

Preface

Publicly held businesses are not directly managed and controlled by the owners. It is not practical for a large number of owners having varied fractions of ownership to 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 interest. But, perhaps this separation of ownership and control in publicly held corporations remains the root cause behind a gamut of corporate governance problems of companies around the world. One of such inevitable corporate governance crises is the existence of a clash of interests between principals and agents. In this regard, the agency cost theory puts forward a clear view regarding how the managers of a business entity tend to prioritize 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 the generation of agency costs. Notably, there is no such clearly prescribed solution to this agency crisis in the literature of corporate finance and governance. However, a number of eminent scholars in this domain have evidenced that, among other factors, the capital structure and the distribution of ownership among different investors have crucial bearings on the overall quality of corporate governance and the agency crisis that arises between managers as the employed agents and shareholders as the principals. The agency theory considers the use of debt as a disciplinary force to restrain this managerial opportunistic behaviour and lower owner-managers’ agency crisis. Again, some studies show how ownership by institutional investors and big promoters ensures efficient monitoring of managerial decisions and actions on their part and reduces owner-managers’ agency problem and thereby improves firm performance. Besides, the ownership concentration is also recognized as a crucial internal governance mechanism to control the ownermanagers’ agency problem. However, a set of literature also provides a 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 the manufacturing firms in India are family-controlled, the largest owner is also supposed to play some special role in the management of affairs of these firms. Against 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

xiv Preface measurement of variable, use of econometric tools, validity of the results, etc. The study develops a set of comprehensible research questions and puts the highest possible efforts to find a 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 strongly balanced panel data consisting of 86 manufacturing firms listed in the BSE 200 index of the Bombay Stock Exchange (BSE) of India for the period of 2008 to 2020 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 the largest shareholders in the Indian manufacturing sector, the study also introduces ownership by the 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 the Generalised Method of Moments (GMM) framework to arrive at the robust results. Based on the findings of the panel data analysis the study concludes that the capital structure choices and various forms of equity ownership including its concentration are significantly related to the financial performance of Indian manufacturing companies. Again, the ownership by largest owners has a non-linear effect on the accounting and market performance of such firms. Therefore, 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 provides them a competitive advantage in terms of low agency problems, minimized internal conflicts, high operational efficiency and improved financial performance.

Abbreviations

AUE BoD BSE CS EBIT EPS EVA FEM GMM IFRS IRR LDTA MBVR MM MVA NBFCs NI NOI NPV NSE ODP OFP OIIN OLS P/E RBI REITs REM ROA ROCE ROE ROI RONW

Assets Utilization Efficiency Board of Directors Bombay Stock Exchange Capital Structure Earnings before Interest and Taxes Earnings per Share Economic Value Added Fixed Effect Model Generalised Method of Moments International Financial Reporting Standards Internal Rate of Return Long-term Debt to Total Assets Market to Book Value Ratio Modigliani and Miller Market Value Added Non-Banking Financial Companies Net Income Net Operating Income Net Present Value National Stock Exchange Ownership of Domestic Promoters Ownership of Foreign Promoters Ownership of Institutional Investors Ordinary Least Square Price Earning Reserve Bank of India Real Estate Investment Trusts Random Effect Model Return on Assets Return on Capital Employed Return on Equity Return on Investment Return on Net Worth

xvi Abbreviations SDTA SEBI SMEs TDTA TFP U.K. U.S. VIF

Short-term Debt to Total Assets Securities and Exchange Board of India Small and Medium Size Enterprises Total Debt to Total Assets Total Factor Productivity United Kingdom United States Variance Inflation Factor

1

Introduction

Background of the study The theoretical framework of corporate finance proposes three functional areas of financial management: financing decision, investment decision and dividend decision or decision relating to the distribution of profit. Financial management of a firm largely revolves around these three major decision areas with the ultimate goal of maximizing the shareholders’ wealth or value. Financing decisions involves a great deal of activities which include deciding on the sources and methods of raising investable funds or capital for the company. This decision basically involves determining the different sources of raising funds for the business, relative proportion and the cost involved with different sources of funds, etc. In brief, financing is a process that involves the determination of the sources of funds considering the economy or cost, convenience, etc., and deciding a judicious mix of different kinds of funds for a company. After deciding the financing aspects of a company, a finance manager needs to think on investment of the raised fund. It involves two major areas of decisions: one relates to investment decision on fixed assets, and another is on current assets. The former process is called capital budgeting whereas the latter one comes under working capital management. Capital budgeting is also termed as investment appraisal. It deals with a whole gamut of activities which includes the allocation of investable funds in different projects or fixed assets considering their earning potential, calculating the payback period, net present value (NPV), internal rate of return (IRR), etc., and finally ensuring the highest return on investment for the firm. The driving objective of capital budgeting is to ensure optimum utilization of investable funds raised by the company. Again, the decision relating to the investment in current assets or management of working capital is another crucial function of finance management. It involves deciding on the investment in different current assets and maintaining a trade-off between liquidity and profitability aspects of the company. Finally, the finance managers have to take the decision relating to the distribution of dividends. The dividend decision involves deciding on what portion of the earning available to equity shareholders would be distributed as dividends and how much should be kept as retained earnings. A well-thought-out and effective dividend policy equally contributes towards achieving the objective of wealth maximization for a firm. DOI: 10.4324/9781003397878-1

2 Introduction Therefore, it is quite clear that the process of investment in assets, capital budgeting, management of working capital, decisions on dividends and retaining earnings all begin after a successful financing decision. Therefore, the decision on financing should be the first and foremost concern for a finance manager. However, all the above functional areas of financial management are closely interrelated and highly interdependent but the process normally begins with an efficient financing decision. In fact, the objective of wealth maximization cannot be achieved until and unless the management takes a rational financing decision that involves the sources and mix of capital (Chakraborty, 1981). Hence, a finance manager has to formulate financing plans and policies keeping in mind the wealth maximization objective of the business concern. It is often observed that business corporations that fail to design a formal plan of their capital and ownership structures are likely to face tremendous financial challenges arising out of an uneconomical and imbalanced financial structure. A major part of financing decision involves the decision on capital structure, i.e. the judicious mixture of owners and borrowed capital, and also the ownership structure, i.e. the composition and concentration of ownership. According to Pandey (1984), a firm always needs to design a formal plan regarding the sources and mix of its funds to be raised to stay away from complications in raising it on favourable terms in the long run and to prevent it from having a costlier and imbalanced capital structure. Theoretically, the capital structure of a firm is known to be the proportion of debt, preference and equity shares in its balance sheet, which reflects the way a firm finances its total investments or assets (Saad, 2010). Looking at the typical capital structure theories, we see the relationship between the capital structure and firm value has been framed under different approaches. The net income (NI) approach gives a positive relationship between these two whereas the net operating income (NOI) approach suggests no relationship. However, the Modigliani and Miller (MM) hypothesis support the NOI approach that the levered firm and the unlevered firm would have the same value, but as the interest on the debt is tax-deductible so the levered firm gets a tax deduction benefit known as interest tax shield and in this way the value of the levered firm increases by an amount which is equal to the total amount of debt capital issued by the firm multiplied by the corporate tax rate. So, MM have developed a behavioural justification which to a large extent supports the NOI approach and argued that without taxes the cost of capital and the market value of the firm would remain constant throughout all degrees of leverage (Modigliani and Miller, 1958). Another approach which is known as the traditional approach is basically a modified form of the NI approach. This approach suggests that the value of the firm increases along with decreasing cost of capital initially up to a reasonable limit after which a further increase in leverage increases the cost of capital and lessens the firm’s value. Moreover, there is sufficient empirical evidence endorsing the relevance of capital structure towards firm operational efficiency, performance and valuation. For instance, Grossman and Hart (1982) see the use of debt as a regulatory instrument in disciplining management and reducing wasteful use of cash flow by creating a

Introduction  3 threat of liquidation. Besides, according to Jensen (1986) when a firm uses more debt, it limits the amount of money available in the hands of the firm’s managers and thereby curtails managerial discretionary expenses, which leads to better firm performance. In the second chapter of this book, we will discuss in detail each of the theoretical approaches to capital structure and also the empirical framework relating to the relationship between capital structure and firm performance. Again, the ownership of companies may take different forms and most of the prominent literature (Berle and Means 1932; Fama 1978; Chakrabarti 2005; Kaur and Gill, 2009) in this field identified a number of forms like concentrated ownership or block holdings, promoters’ ownership (domestic and foreign), institutional ownership, insider or managerial ownership, etc., which affect firm performance. One of the important perceptions behind the favourable impact of different forms of ownership and firm performance in almost all the literature is routed to the efficient monitoring hypothesis. According to this hypothesis, when a substantial fraction of share is held by professional bodies like institutions and even big promoters (having substantial voting rights) they are supposed to monitor the firm and actively take part in the firm’s business decisions, activities, designing of plans and proposals, etc. (Shleifer and Vishny, 1986; Friend and Lang, 1988). However, the literature on corporate finance and governance also suggests an unfavourable impact of ownership structure especially of ownership concentration and firm performance under the expropriation hypothesis. We will discuss all these hypotheses in detail in the subsequent chapters. Therefore, looking at the empirically endorsed theoretical acceptance of the relevance of capital and ownership structure towards firms’ performance, this study makes an attempt to extend and enrich the existing set of literature with some empirical insights from Indian manufacturing firms. Notably, we confine our study to manufacturing firms mainly because the financial statements as a whole, capital structure, assets structure, working capital requirements, etc., of service-sector firms, especially financial institutions, are largely different from that of other firms. Hence, the inclusion of such firms would reduce uniformity and comparability of financial data across firms and results obtained thereby can’t be logically generalized for all the firms. Second, unlike other emerging Asian economies, the concentration of ownership is much more prominent in the manufacturing sector in the case of India (Selarka, 2005; Altaf, 2016). Hence, studies on ownership structure and especially on concentration reasonably prefer manufacturing firms as the study sample. Notably, for the sake of convenience, the terms firm, company, business corporation and business enterprise, etc., are synonymously and interchangeably used throughout this study. Why is this topic worth studying?

Determining the optimum capital structure which represents a judicious blend of owners’ and borrowed funds remains a challenging job for finance managers of any firm and as such for the manufacturing companies in India. Many times, business

4 Introduction firms in India have to pass through the liquidation process due to improper capital structuring (Chadha and Sharma, 2016). Actually, the financing decision is an indispensable part of financial management and a firm has to plan it much before it initiates its capital budgeting processes. The capital structure is called optimum when it maximizes the market value and minimizes the weighted average cost of capital of the issuing company. The capital structures of Indian manufacturing firms mostly contain long-term debt capital, equity capital and preference share capital. The Indian manufacturing firms commonly maintain more equity than debt capital; however, an aggressive approach of financing has been observed in the manufacturing sector as a whole during the last couple of years (Chadha and Sharma, 2016). Therefore, the manufacturing companies in India are gradually increasing their financial risk to take the advantage of financial leverage or the process of trading on equity. Notably, unlike the U.S. and the U.K., Indian publicly held companies, in general, suffer less from a conflict of interest between managers and shareholders, i.e. type I or vertical agency problem (Morck and Yeung, 2003), than between minority and dominant shareholders (type II or horizontal agency problem). Hence, the increased fixed financial obligation through the issue of debt capital may further normalize the former kind of agency problem in the Indian manufacturing sector. Now, the significant role of this debt capital towards agency problem and/ or financial performance in Indian firms is not just mere assumption but is backed by a flurry of research studies based on different industries and classes of companies like cement (Thomas, 2013), steel and iron (Banerjee and De, 2014), Nifty 50 companies (Singh and Bagga, 2019) and manufacturing firms (Pandey and Sahu, 2019). This empirically reinforced assumption has become the driving impetus to include the capital structure of India in the present topic of inquiry. The ownership of Indian manufacturing firms is mainly composed of shares held by domestic and foreign promoters, institutional investors, the public, governments, etc. The Indian promoter group has four major constituents, which are Individual /Hindu Undivided Family, Central/State Government (s), Bodies Corporate and Financial Institutions including banks. The domestic category of promoters holds a significant proportion of shares in Indian companies in general. Likewise, foreign promoters are also one of the important constituents of ‘promoters’ group and consist of three main parties, individual (non-resident/foreign), bodies corporate and institutions. In most of the well-known Indian companies, foreign promoters have a good proportion of shareholding. Another prominent category of investors in Indian firms is banks and non-banking financial companies, mutual fund companies, insurance companies, etc. These are also the important constituents of institutional investors in the Indian manufacturing sector. Besides, corporate ownership in India is traditionally found to be concentrated with family business owners and promoter groups since the time of British managing agencies. It has also been somewhat concentrated in the hands of institutional investors and the state (Balasubramanian, 2010). In many developing countries including India, concentrated ownership is also considered as a part of important internal governance mechanisms (Abbas, et al., 2013) for limiting agency crisis between owners and managers and for mitigating many other governance issues in

Introduction  5 widely held corporations. In Asian economies including India, the degree of type I agency crisis considerably differs among the firms according to concentrated and diffused ownership patterns (Sarkar, 2010). However, in India where concentrated ownership, especially in the hands of promoters, has become a norm rather than an exception, there is a reasonable degree of likelihood of a horizontal or type II agency problem (Morck and Yeung, 2003; Roe, 2004) arising between minority and controlling shareholders. In fact, the shift from democratic to plutocratic voting rights, moving away from one vote per shareholder to one vote per share, has really changed the mechanism of corporate governance and the status & power of large shareholders in public limited companies in many countries (U.S., France, Germany, Britain etc.) including India. Therefore, the various forms of ownership and its concentration or dispersion have significant implications for firms’ overall corporate governance, performance, valuation and investors’ interest protection, etc., not only in the manufacturing category but in almost all joint-stock corporations in India. Motivation of the study The motivation behind this empirical study has come from the felt need to address a couple of research problems. First of all, deciding on a judicious mix of debt and equity capital has always been a managerial challenge for finance managers of publicly held corporations. Now, the Indian firms are not an exception to this issue. The decision on capital structuring has become so crucial and important because of its theoretical acceptance and high empirical endorsement as one of the critical factors to a firm’s operational efficiency and performance. However, the evidence on capital structure and firm performance is mostly inconclusive and equivocal. Therefore, under the circumstance of gradually increasing concerns over capital structure decisions, we think it is very much needed to produce some fresh empirical insights and evidence on this issue. Second, the topic relating to the effect of ownership structure on firm performance and value is much more debated in developed markets of the U.S. and the U.K. and very limitedly addressed in emerging markets like India. The Indian manufacturing sector is featured with a traditionally concentrated ownership pattern along with large diversion in the forms of ownership like promoters’ ownership, institutional ownership, managerial shareholdings, etc. Hence, the sector needs special research attention on the part of scholars. Third, understanding the role of majority shareholders in the Indian manufacturing sector is a matter of great concern. This is because concentrated ownership is considered as one of the important internal governance mechanisms (Abbas et al., 2013) for mitigating principals-agents agency crisis and other governance issues through efficient monitoring of management. On the other hand, it is also assumed that these large owners are supposed to be self-servicing who expropriate the minority shareholders’ rights and consequently cause an unfavourable impact on firms’ financial performance. Therefore, we think it is sensible to examine the actual role that these large shareholders play in the manufacturing firms in India.

6 Introduction Lastly, in India, where most of the manufacturing companies are familycontrolled (Selarka, 2005; Altaf, 2016), the largest owner plays the most dominant role in the management of affairs of the companies. Thus, understanding the special significance of the largest one shareholder towards the governance and performance of Indian manufacturing companies is really important. Objectives of the study This empirical investigation is carried out with the broad objective to add incremental value and thereby qualitatively extend the existing set of literature in the domain of corporate finance and governance in general. To be more specific, the main set of objectives of this study, based on which the whole research is carried out, are outlined below: 1 To explore the relationship between capital structure and corporate performance in the context of Indian manufacturing companies. 2 To inquire the effect of equity-ownership structure and financial performance of Indian manufacturing companies. 3 To establish the empirical relationship between ownership concentration and corporate performance of the selected companies. 4 To produce valuable suggestions and recommendations to the corporate policymakers, practitioners, business analysts and other concerned individuals associated with corporate finance and governance. Keeping in mind the above set of objectives, the study frames the following hypotheses to be tested: Hypothesis I

Null Hypothesis (H0): There is no relationship between capital structure and corporate performance. Alternative Hypothesis (H1): H0 is not true. Hypothesis II

Null Hypothesis (H0): There is no relationship between ownership structure and corporate performance. Alternative Hypothesis (H1): H0 is not true. Hypothesis III

Null Hypothesis (H0): Ownership concentration does not significantly affect corporate performance. Alternative Hypothesis (H1): H0 is not true.

Introduction  7 Scope of this work The present study covers a crucial area in the domain of corporate finance and governance. The study basically deals with the two major aspects of financing, i.e. deciding on the composition of owned and borrowed funds, what we typically refer to as capital structuring, and the distribution of owners’ funds among different kinds of owners, i.e. deciding on the ownership structure. More specifically, the study makes an attempt to interlink the capital structure or degree of financial leverage and ownership structure with corporate financial performance. Notably, financial performance is further segregated into accounting performance and market performance. The study considers Indian manufacturing companies to establish the relationship between capital structure, ownership structure and financial performance. To be more specific, it chooses a sample of 86 manufacturing companies from the BSE 200 index of the Bombay Stock Exchange of India. Therefore, the inferences that could be drawn from the study would be highly relevant and useful for the Indian economic context. Especially, the study findings would represent the status of the manufacturing sector of the economy for the period of 2008–2020. However, the key findings and thereby drawn inferences of this study are expected to be replicated for other emerging market economies with similar corporate legal structure. Notably, the findings and suggestions especially relating to ownership concentration would have considerable relevance and implications for the corporate policymakers of other Asian countries where ownership concentration has become a common phenomenon like India. Chapter outline The study presented in this book is composed of seven chapters. It begins with an introductory chapter highlighting the fundamentals of the work. Here the authors attempt to provide an overview of the study. This chapter presents a detailed description of the study background, relevance and motivation behind this investigation, the driving objectives of the study, the novelty and a chapter plan of the study. The second chapter of the book, which is entitled ‘Capital Structure and Corporate Performance: Theories and Literature’, draws on the theoretical foundation supplemented by empirical evidence on the relationship between capital structure or financial leverage and corporate performance. The various theories of capital structure are discussed in light of its relationship with corporate performance. The third chapter provides a lucid view of the theoretical and conceptual aspects relating to the association between various forms of ownership and firm performance. The chapter also delves into the existing literature on the topic and provides a detailed description of the empirical evidence documented so far. The fourth chapter attempts to develop the theoretical understanding of the readers relating to the impact of ownership concentration on the agency problem of publicly held corporations. It also covers the important empirical insights produced

8 Introduction by several studies regarding how majority or controlling owners play an effective role in moderating agency problems in jointly held corporations and ultimately affect corporate performance. The second to fourth chapters are immensely useful and worthy to read before going to the empirical part of this book, which begins from the fifth chapter. The fifth chapter presents one of the vital parts of the study. It involves detailing the data and methodology used for the empirical investigation, estimation of a range of statistical tests and undertaking suitable econometric analyses to establish the empirical relationship between capital structure, equity-ownership structure and corporate performance. The authors in this chapter draw meaningful inferences based on empirical results and findings in the context of Indian manufacturing companies. Similarly, the sixth chapter covers empirical analyses on the relationship between ownership concentration and firm performance. The chapter also includes the analysis of the non-linear effect of the largest shareholder on the performance of Indian manufacturing companies. Finally, the seventh chapter of this book, being the last chapter, concludes the empirical research and attempts to provide valuable suggestions and policy recommendations that would be immensely useful for corporate policymakers, corporate regulatory institutions and business analysts especially ones who deal with corporate finance and governance. The chapter also presents the main limitations of the study and draws directions for future research initiatives. References Abbas, A., Naqvi, H. A., & Mirza, H. H. (2013). Impact of large ownership on firm performance: a case of non-financial listed companies of Pakistan. World Applied Sciences ­ Journal, 21(8), 1141–1152. Altaf, N. (2016). Economic value added or earnings: what explains market value in Indian firms? Future Business Journal, 2(2), 152–166. Balasubramanian, N. (2010). Corporate governance and stewardship: emerging role and responsibilities of corporate boards and directors. New Delhi: Tata McGraw Hill. Banerjee, A., & De, A. (2014). Determinants of corporate financial performance relating to capital structure decisions in Indian iron and steel industry: an empirical study. Paradigm, 18(1), 35–50. Berle, A. A., & Means, G. C. (1932). The modern corporation and private property. New Brunswick. NJ: Transaction. Chadha, S., & Sharma, A. K. (2016). An empirical study on capital structure in Indian manufacturing sector. Global Business Review, 17(2), 411–424. Chakrabarti, R. (2005). Corporate governance in India: evolution and challenges. ICFAI Journal of Corporate Governance, 4(4), 50–68. Chakraborty, S. K. (1981). Financial management and control: text and cases. New Delhi: Macmillan India Ltd. Fama, E. F. (1978). The effects of a firm’s investment and financing decisions on the welfare of its security holders. The American Economic Review, 68(3), 272–284.

Introduction  9 Friend, I., & Lang, L. H. (1988). An empirical test of the impact of managerial self-interest on corporate capital structure. The Journal of Finance, 43(2), 271–281. Grossman, S. J., & Hart, O. D. (1982). Corporate financial structure and management incentives. In John J. McCall (Ed.), The Economics of Information and Uncertainty. Chicago, IL: University of Chicago Press, 107–140. Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323–329. Kaur, P., & Gill, S. (2009). Patterns of corporate ownership: evidence from BSE-200 index companies. Paradigm, 13(2), 13–28. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48, 261–297. Morck, R., & Yeung, B. (2003). Agency problems in large family business groups. Entrepreneurship Theory and Practice, 27(4), 367–382. Pandey, I. M. (1984). Financing decisions: a survey of management understanding. Economic and Political Weekly, 19(8), M28–M31. Pandey, K. D., & Sahu, T. N. (2019). Debt financing, agency cost and firm performance: evidence from India. Vision, 23(2), 267–274. Roe, M. J. (2004). The institutions of corporate governance. Discussion Paper No. 488, Harvard Law School. Saad, N. M. (2010). Corporate governance compliance and the effects of capital structure. International Journal of Economics and Finance, 2(1), 105–111. Sarkar, J. (2010). Ownership and corporate governance in Indian firms. Corporate governance: an emerging scenario, National Stock Exchange of India Ltd, 217–267. Available at: https://nseindia.com/research/dynaContent/CG_9.pdf Selarka, E. (2005). Ownership concentration and firm value: a study from the Indian corporate sector. Emerging Markets Finance and Trade, 41(6), 83–108. Shleifer, A., & Vishny, R. W. (1986). Large shareholders and corporate control. Journal of Political Economy, 94(3), 461–488. Singh, N. P., & Bagga, M. (2019). The effect of capital structure on profitability: an empirical panel data study. Jindal Journal of Business Research, 8(1), 65–77. Thomas, A. E. (2013). Capital structure and financial performance of Indian cement industry. BVIMR Management Edge, 6(1), 44–50.

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Capital structure and corporate performance Theories and literature

Introduction Every empirical research must be routed to a strong theoretical foundation supported with sufficient empirical evidence for the purpose of framing the research questions and hypotheses. This empirical investigation is not an exception to this view. Here, in this chapter, we will present a detailed description of the theoretical foundation along with the empirical observation, insights and findings documented in the previously conducted research studies on capital structure. Specifically, in this chapter, we will discuss the various existing and important theories of capital structure, the concepts of agency problem, the theoretical postulations relating to the association between capital structure and the agency problem that arises between the principals and agents of a publicly held corporation due to the separated ownership and control structure. The chapter also provides a brief description of the conceptual aspects of corporate financial performance. The chapter will cover an extensive illustration of the existing set of literature from The Wealth of Nations (Smith, 1776) to the quite recent one on the relationship between capital structure and corporate performance. Capital structure theories Capital structure theories represent varied views and perceptions towards capital structure and especially its association with the profitability and market valuation of a firm. A detailed discussion on the various approaches or theories of capital structure would help us to understand the significance of capital structure and the basis of its determination and to build a concrete perception on whether and to what extent capital structure matters in a business firm. Net income (NI) approach

Although the concept and theory of capital structure started receiving much research attention after Modigliani and Miller’s (1958) work, which viewed capital structure to be irrelevant to firms’ overall cost of capital and market valuation, it was Durand (1952) who first gave a formal capital structure theory and viewed capital structure to be relevant to a firm’ value and overall cost of capital. DOI: 10.4324/9781003397878-2

Capital structure and corporate performance  11 According to Durand (1952), the value of the firm would be highest with the lowest weighted average cost of capital when the proportion of debt in the capital structure reaches its maximum level. This approach to interlink capital structure with firms’ value is known as the NI approach. According to this approach, any alteration in the ratio of debt and equity in the capital structure would lead to a consequent and corresponding change in the overall cost of capital as well as the market valuation of firm. Therefore, a business firm can influence its value by prudently altering its proportion of the debt capital, i.e. the degree of financial leverage in its capital structure. According to the said approach, higher the financial leverage, the lower will be the weighted average cost of capital of a firm. As a consequence, the return available to equity shareholders as well as the overall market value of the firm will go up. On the other hand, if the financial leverage reduces, the weighted average cost of capital of firm would increase as a result of this, and the value of the firm would come down. However, according to Durand (1952) the NI approach would only hold under the following assumptions: 1 There are no corporate taxes. 2 The cost of debt capital (Kd) is less than the cost of equity capital (Ke), i.e. Kd < Ke. 3 The financial leverage or use of debt capital does not influence the risk perception of the investors. 4 The cost of debt capital and the cost of equity capital will remain unchanged irrespective of any changes in the debt-equity mix of the firm. 5 The dividend payout ratio is 100 percent, which means that a firm must not keep a part of the profit as retained earnings. According to the NI approach, the value of the firm is ascertained as follows: V=E+D Where V = Value of the firm, E = Market value of the equity D = Market value of the debt Again, the market value of equity can be determined as below: E = Ee / K e where Ee = Equity earnings (i.e. earning available for equity shareholders) Ke = Cost of equity capital (i.e. equity capitalization rate) The market value of debt can be determined as follows: D = I / Kd Where I = Interest of debt capital Kd = Cost of debt capital

12  Capital structure and corporate performance The overall cost of capital or weighted average of the cost of debt and cost of equity capital (K0) can now be estimated as

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K 0 = E/V K e + D/V K d K 0 = EBIT / V Therefore, the total value of the firm (V) = EBIT / K0 However, the principal shortcoming of the NI approach is that it assumes a constant cost of debt and cost of equity capital. Empirical studies evidenced that with the increase of debt in the capital, the cost of equity tends to rise and after a certain scale of leverage the cost of debt capital also starts rising. Furthermore, the splitting of the entire earning of the firm between debt and equity holders to determine market valuation is highly criticized and is found to be impractical. Besides, assumptions like equal risk sensitivity among all investors, 100 percent dividend payout by the firm and no corporate tax, etc., have no practicality. Net operating income (NOI) approach

The NOI approach of capital structure was also propounded by Durand (1952) but shared a converse view than the NI approach. This approach views that the value of the firm is not affected by the adjustments in the capital structure. In other words, this approach says that the increasing use of debt by a firm will not play any role in determining the weighted average cost of capital and the market value of the firm. The NOI approach finally concludes that the capital structure decision of a firm is irrelevant and hence there remain no such things as optimal capital structure. In other words, any capital structure or combination of debt and equity can be considered as an optimal capital structure. The underlying assumptions based on which the NOI approach operates are as follows: 1. There are only two sources of funds, i.e. debt and equity. 2. The cost of equity capital (Ke) is greater than the cost of debt capital (Kd), i.e. Ke ˃ Kd. 3. The overall cost of capital (K0) of the firm is constant irrespective of the degree of financial leverage or intensity of the business risk of the firm. 4. The investors see the firm as a whole and thus capitalize the total earning to determine the value of the firm. In another way, the split between equity capital and debt capital is no more relevant in determining the value of the firm. 5. The value of the equity capital (E) is a residual value and it is obtained by deducting the value of debt (D) from the value (V) of the firm as a whole, i.e. E = V−D. 6. For any degree of financial leverage of the firm, the cost of debt capital (kd) remains constant. 7. The incremental proportion of debt in the capital structure amplifies the risk for equity holders, which leads to increased cost of equity capital (Ke).

Capital structure and corporate performance  13 The cost arises out of an increase in the equity capitalization rate (Ke), which would exactly sets off the benefits of employing cheaper debt. 8. There are no corporate taxes. This approach determines the value of the firm as follows: Value of the firm (V) = EBIT / K0 Here the cost of equity capital can be estimated as follows:

(

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K e = K 0 + K 0 – K d D/E Looking into the limitations of the NOI approach we see that it assumes that the benefits of using cheaper debt capital will be exactly nullified or set off against the enhancement of cost of equity capitalization rate, which leads to no change in the value of the firm. But it is quite unrealistic to assume that the cost of equity will increase exactly to that level which completely neutralizes the positive impact of the increased debt issued. Again, non-existence of corporate tax is also an impractical base to establish this approach in today’s world. Finally, the non-existence of the optimal capital structure of any firm is also not an acceptable argument. Modigliani-Miller hypothesis

Modigliani and Miller (1958) have developed and explained a theoretical viewpoint regarding the capital structure of the firm. The Modigliani and Miller (MM) hypothesis shares quite a similar view as the NOI approach of capital structure. The MM hypothesis postulates that in the absence of any corporate taxes, the change in the degree of leverage of a firm will not affect the firm’s overall cost of capital as well as its market value. The MM hypothesis of capital structure was proposed under the ideal capital market conditions. However, there are several assumptions of this approach and these are as follows: • Capital markets are perfect, implying that there is no transaction cost; all investors are rational, truly informed and free to buy and sell any share. • The investors have the same expectation regarding a firm’s operating income. • All firms belong to the same risk class. • The dividend payout ratio is 100 percent. • Securities are infinitely divisible. • No investor can individually influence the market price of securities. • There are no flotation costs. • There is no corporate tax. The MM hypothesis states that the value of the firm and the overall cost of capital is independent of its capital structure. Here, V = E + D

14  Capital structure and corporate performance Or, V = EBIT / K0, where EBIT refers to earnings before interest and tax Or, K0 = EBIT / V K0 = (E/V) Ke + (D/V) Kd Here, V = Value of the firm E =Market value of the equity D = Market value of the debt Ke = Cost of equity capital Kd = Cost of debt capital K0 = Overall cost of capital Here, as both EBIT and overall cost of capital are independent of the capital structure of a firm, the value of the firm remains unaffected by the capital structure choices. According to this hypothesis, two firms with identical nature except for their capital structure choices can’t attain varied market value and overall cost of capital. Any difference in their market value is restored through a process of arbitrage. Here arbitrage process refers to the practice of buying securities from one market at lower prices and selling them at a comparatively higher price in another market. Traditional approach

The traditional approach of capital structure is in between two extreme prepositions or views, i.e. relevance and irrelevance of capital structure postulated by NI and NOI approaches respectively. In other words, this approach of capital structure theory involves a blend of two competing postulations previously developed regarding the relationship between the cost of capital, leverage and value of the firm. This approach suggests that through judicious use of both equity and debt capital, the cost of capital of the firm can be minimized and consequently the value of the firm can be maximized. However, the said approach completely presumes neither constant cost of equity and declining overall cost of capital like the NI approach nor the increasing cost of equity and constant overall cost of capital like NOI approach. According to the traditional approach, there are three stages of movement of the weighted average cost of capital based on the degree of leverage of the firm. At the initial stage, an increase in financial leverage, i.e. the use of cheaper sources of capital, leads to a reduction in the overall cost of the firm. This is because in this stage the infusion of more debt capital in the capital structure does not impact the cost of debt and cost of equity capital. Both of the capitalization rates remain fixed or enhance negligibly. In the second stage, after a certain degree of leverage, due to the increased financial risk perception of the equity shareholders, the cost of equity starts rising. Here, the rise in the cost of equity (due to added financial risk arising out of higher leverage) will just equalize the benefit of using cheaper debt capital. It will continue to go up to a certain degree of leverage. Hence, in this range of the degree of leverage, the average cost of capital will remain unchanged. The degree of leverage at this stage represents an optimum capital structure because here the cost of capital lies at its minimum range and hence the value of the firm will reach its maximum.

Capital structure and corporate performance  15 The third stage is the stage of the declining value of the firm. At this stage value of the firm starts declining along with the further rise in the financial leverage of the firm. This is because if the firm introduces more debt capital, i.e. enhances its degree of leverage (beyond the second stage), the risk perception of both equity and debt holders will increase significantly. Therefore, the overall capitalization rates for both the debt and equity capital start rising and the value of the firm starts declining. Trade-off theory

By providing a modified MM proposition, the trade-off theory suggests that the value of the firm becomes maximized if the capital structure becomes optimized. This capital structure optimization is only possible through the trade-off between the costs of financial distress and interest tax shields, which occurs due to the use of debt capital. In other words, the trade-off theory proposes that a firm by balancing the costs and benefits of an added unit of debt capital in the capital structure can maximize the value of the firm. As per this theory, the moderate debt-equity ratio is rational for a firm. Financial distress refers to the risk factors associated with using debt capital like the risk of bankruptcy, loss of creditworthiness, etc. The interest tax shield is an observable and quantifiable benefit but the costs involved with financial distress are not. Therefore, a company should be more cautious regarding this and must keep up the safety of margin before taking the benefit of the tax shield. Hence, according to the trade-off theory (Singh and Kumar, 2008), the advantage of the tax shield is offset by the costs of financial distress. It says that the firm will use debt capital in its capital structure up to the point where the marginal value of tax shields on additional debt is exactly offset by the increased costs of financial distress. This approach measures the firm value as below: V = V/ + Present value of interest tax shields– Present Value of Costs of Financial Distress Where V/= the firm value with all equity financing. The pecking order theory

The pecking order theory was introduced and popularized by Myers and Majluf (1984). The theory basically explains how asymmetric information is responsible for the enhancement of cost of finance in a corporation. This theory believes a firm with growth opportunities wants added financing. This theory also assumes that the capital market is semi-perfect because there is no information asymmetry between the insiders and the outsiders of a firm. In such circumstances, there are three sources of finance, namely, internal funds, debt and new equity. For a corporation, an internal source of finance will be the first preference, followed by debt capital, whereas equity will be considered at last. The pecking order theory suggests that the firms will rely first on internal sources because the information asymmetry costs associated with it are the lowest and lastly equity because it is attached to the highest information asymmetry costs.

16  Capital structure and corporate performance Pecking order theory views that the way a firm finances would send an important signal to the public about the performance of the company. According to this theory, when a firm finances itself internally, the public perceives the company as financially strong. If a firm chooses to finance its investments by issuing debt, it signifies that the management is confident enough about the ability of the firm to bear its fixed financial obligations. Lastly, if a company finances itself by issuing equity shares, it bears a negative signal that the management perceives its stock to be overvalued in the market and the company seeks to make money out of it before the market price of the shares falls. Market timing theory

The market timing theory of capital structure has been put forward by Baker and Wurgler (2002). The theory postulates that the current capital structure of a firm is the collective effect of past attempts to time the equity market. According to this theory, the source of capital is determined based on the market value of the share of the company. In other words, the insight of market timing is that the firm issues new shares when it thinks its shares are overrated and it has the opportunity of collecting funds by utilizing its equity capital. On the other hand, firms repurchase their own shares when they consider these to be underrated. Similarly, fluctuations in stock price will affect corporate financing decisions as well as the capital structure of a corporation. Therefore, according to this theory a firm normally doesn’t bother about equity and debt financing and they just choose the form of financing which, at that point in time, seems to be more valid and beneficial in terms of value creation. Therefore, according to Baker and Wurgler (2002) market timing is a crucial determinant of a firm’s capital structure or use of debt and equity and firms do not generally predetermine any debt-equity mix; rather, they just choose the form of financing which at the time of new issue seems to be more valued by financial markets. Thus, from the above discussion it can be understood that theoretically the capital structure, i.e. mix of debt and equity capital of a company, has crucial importance and bearing on the governance and performance of companies. Concept of vertical agency problem A jointly held corporation prominently faces two types of agency problems, namely, vertical and horizontal agency problem. The vertical agency problem refers to the conflict of interest between owners of the concern and management or controlling agents. The root cause of this crisis is the separation of ownership and control in the modern corporation (Berle and Means, 1932). Notably, the agency contract, i.e. the contractual relationship between the principals and agents, is referred to as ‘incomplete’ because of the fact that, although typically the agents are supposed to think and act in line with the best interest of the principals, in practice, they take the benefits of free-riding opportunities to realize their private benefits at the expense

Capital structure and corporate performance  17 of the principals (Shleifer and Vishny, 1997; Kirchmaier and Grant, 2005). In this way, the separation of these two entities results in a substantial conflict of interest (Jensen and Meckling, 1976; Shleifer and Vishny, 1997) and it is dubbed in the corporate governance literature as type I or vertical agency problem. Capital structure and vertical agency problem The capital structure of a corporation is both conceptually and empirically associated with vertical agency problem. A flurry of empirical evidence is there which established a strong association between the owner-managers’ agency problem and the capital structure of a firm. According to most of such empirical investigations, firms’ agency cost, performance and value are found to be significantly affected by the changes or modifications in the capital structure or degree of leverage. There is sufficient empirical support for this fact that when a firm issues more debt, it limits the cash available in the hands of managers (Jensen, 1986) as a result of increased fixed-interest payment obligations. According to Grossman and Hart (1982), high debt can play an instrumental role in disciplining managerial discretionary expenses and wasteful use of cash flow by creating a threat of liquidation as a consequence of incapability in repayments. In this way, capital structure can regulate the vertical agency problem and contribute to better financial performance. Corporate performance: a theoretical discussion Performance can be simply understood as the degree of sincerity, accuracy, efficiency and effectiveness with which a particular activity is performed. However, to be practical, the performance of a business concern is not just about how well a particular activity is performed but much about how far the predetermined goal attached to the activity is accomplished. For instance, an activity may sometimes be carefully and effectively undertaken with the highest possible efforts, but if such efforts don’t bring in any goal-oriented outcomes then the activity wouldn’t be treated as well-performed. Therefore, we must understand that the term ‘performance’ typically refers to the concluding consequence or outcome of any activity. However, there are a variety of definitions that can be given to the term ‘performance’. A formal way of defining performance is the degree of accomplishment of a given task measured against a preset standard of accuracy, completeness, economy and speed. In the context of a business concern, it may imply the level of efficiency and effectiveness with which a predetermined goal is accomplished by the organization. To measure performance involves evaluating a numeric outcome through analysis that indicates how well and how far an organization is achieving its predetermined set of objectives. Performance measurement can involve an examination of the performance of many aspects of a business concern such as accounting, finance, marketing and sales, engineering, production and materials management, research and development, etc.

18  Capital structure and corporate performance According to Armstrong and Baron (1998), effective performance measurement should contain the following characteristics: • It should be based on and related to the strategic goals of the business concern and it should also be organizationally significant. • It should be relevant to the objectives of the business and the individuals concerned. • It should reasonably involve measurable output, accomplishment and behaviour that can clearly be defined and for which evidence can be made available. • It should be as precise and specific as possible in accordance with the purpose of measurement and availability of data. • It should put forward a solid foundation for feedback and action. • It should be comprehensive and it must cover all the key aspects of performance. To ensure the successful implementation of a firm’s business strategy, the implementation of an efficient performance measurement is of high importance. It is an instrument through which an organization monitors and controls the important aspects of its plans and programs, processes and systems designed to fulfil its ultimate goal. By providing adequate and crucial performance information, it enables an organization to ensure efficient and effective decision-making from operational to the strategic level of business. Moreover, there are a lot of other reasons as to why an effective measurement of the financial performance of an enterprise becomes imperative. In a very typical sense, performance measurement provides an efficient tool which helps in determining the efficiency and effectiveness of an organization’s current system. In organizations, financial measures of performance become the basis for appraising the quality of financial management. The financial scorecard indicates how well finance managers have utilized the financial resources in the direction of shareholders’ value creation. However, one must understand that not only the inside stakeholders (viz., shareholders, employees, etc.) but outsiders like creditors, governments and the public are also equally keen to get a true picture of the financial or non-financial performance of a business organization. In a business organization, the performance may be financial or non-financial in nature. Financial performance is associated with the accomplishment of financial objectives whereas attainment of non-financial performance is attached to the attainment of the non-financial objectives of an organization. Therefore, in a case when a business concern seeks to attain a financial goal like profitability, growth, market value then the efficiency and effectiveness of attaining such a goal is referred to as financial performance. On the other hand, when a business concern strives to attain non-financial goals like customer satisfaction, social performance, environmental performance, etc., then the efficiency and effectiveness of attaining any of such goals is referred to as non-financial performance or strategic performance (Santos and Brito, 2012). Coming to the financial perspective, financial performance refers to the degree of accomplishment of a goal attached to the act of a financial activity. In other

Capital structure and corporate performance  19 words, financial performance refers to the degree to which a financial objective is accomplished. Financial performance can be classified into two types: accounting performance and market performance. Commonly used accounting performance measures

A Return on Assets (ROA): ROA is a very common measure of companies’ accounting performance. In a business concern, profits are often viewed in relation to its investment in total assets. The ratio between the return in terms of net profit of a firm and its average total assets is called return on assets. For instance, if the ROA of a firm at the end of a particular financial year is, say, 12 percent, it means the return of the firm is 12 percent of its total assets’ investment value. A high ROA suggests good profitability condition and vice versa. B Return on Equity (ROE): It is another important and widely used measure of accounting performance of firms where the return in the form of profit is viewed in relation to the equity share capital of a firm. Unlike ROA, it expresses the profitability of a firm exclusively in relation to the owners’ equity investment. ROE specifically represents how the equity shareholders are faring during a financial year. Since benefiting the owners is the principal goal of a publicly held company, ROE in this sense is the true indicator of performance (Ross et al., 1996). Now, a high ROE indicates greater efficiency of the firm in utilizing its owners’ capital and vice versa. C Return on Capital Employed (ROCE): The profitability ratio of a firm in relation to total capital employed, which includes owners’ equity and long-term liability in the form of debt, capital is called return on capital employed. It is a measure of the accounting performance of a firm which indicates how well a firm has used its total capital supplied by the creditors/lenders and owners together. D Return on Net Worth (RONW): Net worth refers to what a business unit actually worths. It is the shareholders’ equity that remains after deducting the assets from all outside liabilities. RONW is also considered as an important measure of the profitability of a business concern. It is the percentage of return of a firm on its shareholders’ equity. E Profit Margin: Many times profit margin is also considered a good indicator of a firm’s accounting performance. This represents the profit generated by a business unit for every unit of its revenue or sales. It can be measured in the form of gross profit and net profit. All these above-discussed measures of accounting performance are theoretically and empirically recognized to be highly sensitive to the capital structure and ownership structure of companies. The empirical studies have established how these variables get influenced with changing debt-equity combination (Grossman and Hart, 1982; Jensen, 1986) and also with alteration in the concentration and composition or distribution of ownership among the public, promoters, institutional investors, etc. (Abor, 2005; Haldar and Rao, 2011; Pandey and Sahu, 2017b, etc.).

20  Capital structure and corporate performance Commonly used market performance measures

A Market to Book Value Ratio (MBVR): The market price of shares of a firm is compared with its actual book value to know whether the firm’s securities are overvalued or undervalued. The ratio between the market price of share of a firm and its book value is called the market to book value ratio. When the MBVR of a firm is more than one, it indicates the shares of the firm are valued more than their actual book value. B Price Earnings (P/E) Ratio: It is the ratio between the market value per share of a firm and its earnings per share (EPS). It reveals how much price an investor has to pay for a unit of earning. It is widely calculated and used by investors and security analysts to determine the firm performance and future expectations. C Tobin’s Q: It was first introduced by Kaldor (1966). It represents the ratio between the existing market value of assets of a firm (taken as existing market price of equity and debt capital) and their replacement cost, i.e. cost of such assets if they are newly purchased from the market (taken as the book value of equity and debt capital). For the sake of convenience, Tobin’s Q is normally determined by dividing the market value of equity and debt of a firm by the book value of total assets. A Tobin’s Q of 1.0 reveals that the market value of securities of a firm solely reflects its book value. When Tobin’s Q is greater than 1.0, we should assume that the market value is greater than the recorded value of the company’s assets. If Tobin’s Q is less than 1.0, the market value is less than the recorded value of the firm’s assets and it refers to an undervaluation of securities by the investors in the market. D Market Value Added (MVA): Investors and analysts are often very much interested in calculating another market performance called market value added. It represents the difference between the market value of a company at a particular time and the amount of capital the investors contributed towards it. Market Value added = Market Value of the firm (Market value of equity and debt) – Capital investment in the firm. A high or positive MVA indicates the creation of wealth for the shareholders of the firm and a negative MVA reveals that the firm has destroyed the shareholders’ wealth or value. E Economic Value Added (EVA): EVA is an absolute measure of a firm’s performance, which refers to the value that remains after all the kind of capital providers including stockholders are compensated. It doesn’t only consider the debt interest but also covers the cost of equity. It is similar to the measurement of net present value (NPV) but where the NPV applies to the whole period of investment, EVA can be used for periodical performance measurement. Now, like accounting performance measures, the market-related performance measures discussed above are also highly considered to be responsive to the capital structure and ownership structure policies of companies. The studies like Kumar and Singh (2013), Altaf and Shah (2018), Pandey and Sahu (2017a,

Capital structure and corporate performance  21 2019a, 2019b), etc., established a significant empirical association between capital structure and/or ownership structure including concentration and one or more of the above-discussed market performance measures in the context of different market economies. Capital structure and corporate performance: empirical evidence The decision relating to the determination of an optimum capital structure is known to be a challenging issue for many business corporations whether small, medium, or large. The decision is so crucial because there is high theoretical acceptance and empirical evidence on the effect of capital structure or the magnitude of leverage on corporate performance including profitability and market valuation. Long before, Smith (1776) expressed great concern over the opportunistic behaviour of managers as the employed agents of the owners. According to him, in a firm with separated ownership and control, the managers can’t be sensibly assumed to be as anxious and vigilant as the partners in a partnership business. Berle and Means (1932) also describe the existence of agency problem due to the separation of ownership from control. More specifically, Wippern (1966) investigates the relationship between financial leverage and firm value. The researcher uses debt to equity ratio as a measure of financial leverage and the ratio of earnings to market value of common stock as a performance indicator. The findings of the study inferred a positive effect of debt on firm value. In a more formal approach, Jensen and Meckling (1976) describe the issue under agency cost theory. The theory postulates that a high degree of leverage is supposed to normalize agency cost by curtailing managerial opportunism and disciplining managers to act in line with the best interest of the firm. Now, this further results in improved operational efficiency and performance of firms. Conversely, Myers (1977) disapproves the view of Jensen and Meckling (1976) and refers to high debt as a potential source of clash of interest between equity and debt holders as a result of default risk which brings another agency cost. It creates a problem, which Myers termed as ‘underinvestment’ or ‘debt overhang problem’. Therefore, debt may create over-restrictions on investments and ultimately unfavourably affect firm performance. However, Grossman and Hart (1982) support the view of Jensen and Meckling (1976) and explain how debt can act as a disciplinary instrument by creating incentive effects from the threat of liquidation which further restrains managerial opportunism. Further, Barry (1997) carried out doctoral research on the reasons why companies change their leverage or capital structure and whether they do it with the aim of reaching a point of optimum capital structure. The study finds very limited evidence on the existence of a targeted optimum capital structure as proposed by the static trade-off theory of capital structure. Rather, the study findings strongly endorse the view of pecking order theory that there is no such targeted capital structure for a firm. Nevertheless, Blanchard et al. (1994) show how the management of a publicly held company carelessly uses excess cash flows from the business.

22  Capital structure and corporate performance According to them, the wasteful spending of cash flows out of self-interest in unprofitable avenues like acquisitions of unrelated firms and other activities many times can’t add any incremental value to the firm. In such a situation debt which brings fixed payment obligations for the business is supposed to restrict the wasteful use of funds by management (Jensen, 1986). But, this fixed committed payout may sometimes put over-restrictions on managers with regard to investments and there is a possibility that out of these over-restrictions, managers start forgoing economically viable (projects with positive NPV) projects (Stulz, 1990). In this case, the use of debt may bring in an adverse effect on financial performance. Apart from these, as interest on debt is exempted from corporate tax so the use of debt reasonably cuts the overall cost of capital for a firm (Modigliani and Miller, 1958). At the same time, additional debt comes with additional bankruptcy cost and therefore in a case when the bankruptcy cost outweighs the benefits of tax-exempted interest, financial performance is supposed to worsen. Therefore, a firm must proceed with proper cost-benefit analysis while using additional debt capital (Harris and Raviv, 1991). According to Modigliani and Miller (1958) under the assumption of the absence of taxes and transaction costs debt does not affect a firm’s value and the value of a levered firm equals the value of an unlevered firm. Notably, Agrawal and Knoeber (1996) carry out a very prominent research investigation in this direction. The researchers make an attempt to find out the important instruments that can restrain the owner-managers agency problem. Among several factors studied, the researchers find leverage as one of the crucial factors that can be used as an instrument to curtail agency costs and improve corporate performance. Again, Krishnan and Moyer (1997) undertake eminent research on the effect of capital structure on the financial performance of companies. The study makes a cross-country investigation where it considers a total of 81 companies from four countries, namely, Malaysia, Singapore, Hong Kong and Korea. The study also tries to examine whether the capital structure and performance of companies are affected by the country origin of the companies. Finally, the study finds no such significant relationship between capital structure and financial performance of the sampled companies. Interestingly, the country origins of the companies are found to be an important factor for both capital structure and financial performance. The study again evidences the effect of corporate taxes on the decisions relating to the capital structure of such corporations when the effect of country origin is controlled. To conclude, the study to some extent endorses the view of static trade-off theory of capital structure and also disapproves the postulation of pecking order theory as such effect is not evidenced in the analysis of the sample firms. Coming to the studies of the 21st century, Holz (2002), in the context of the state-owned enterprises of China, establishes a positive relationship between capital structure and firm performance. Based on the findings, the study suggests that in China the industrial state-owned enterprises-related reforms that put forward a debt alleviation strategy are misguided. A few years later, Abor (2005) based on the analysis of data of companies listed on the Ghana Stock Exchange (GSE), showed how the access borrowing cost of long-term debt outweighs the interest tax shield, which leads to bankruptcy risk and low firm performance measured by ROE.

Capital structure and corporate performance  23 More specifically, the study confirms a positive relationship between short-term debt to total assets (SDTA) and ROE and a negative relationship between longterm debt to total assets (LDTA) and ROE. In addition to this, Campello (2006) addresses an important research question regarding whether use of debt capital hurts or boosts performance in the context of product markets. The study uses a sample of 115 industries for a period of 30 years. The study finds that a moderate level of debt can lead to improved firm performance due to relative-to-rivals sales gain. However, higher indebtedness may lead to underperformance in the product market. Moreover, Rao et al. (2007) in their study of 93 non-financial Oman companies listed on the Muscat Securities Market (MSM) come to the conclusion that the tax savings from using debt become insufficient to meet the cost of debt and the cost of debt is found to be greater than the rate of return. This is due to the high borrowing costs in the Oman economy and the presence of an under-developed debt market in the economy. Therefore, finally use of debt is found to have a negative impact on the financial performance of Oman firms. Concurrently, Abor (2007) tests the effect of leverage on the financial performance of small and medium-sized enterprises (SMEs) from Ghana and South Africa. The study concludes that, by and large, capital structure has a significant negative impact on the performance of SMEs of the concerned markets. The study specifically finds long-term debt to be detrimental to the performance of the firms. Again, Zeitun and Tian (2007) make an attempt to establish the empirical association between capital structure and firm performance in the context of 167 nonfinancial Jordanian companies during the period of 1989–2003. The study uses ROE, ROA, etc., and Tobin’s Q, MBVR, etc., as measures of accounting and market-related performance of Jordanian companies respectively. The study using panel data regression analysis establishes a significant and negative relationship between capital structure and both of the measures of firm performance. However, the study interestingly establishes a positive relationship between SDTA and one of the measures of market performance, i.e. Tobin’s Q. The study additionally notes that both the leverage and financial performance of Jordanian companies significantly increased during the Gulf Crisis of 1990–1991 and after controlling the effect of macroeconomic and some regional factors, the crisis had a positive impact on Jordanian firms’ performance. Later on, Mahakud and Misra (2009) examine the relationship between leverage on financial performance by using a panel data set constructed from a sample of 5,258 Indian companies for the period 2000–2001 to 2006–2007. The study uses ROCE, EPS, ROE and EVA as proxies for the financial performance of sample firms. The study considers the leverage ratio measured by the total debt to equity ratio as the main explanatory variable of the study. Applying the dynamic panel data model through the generalized method of moments (GMM) method, the study finds leverage to have a statistically significant and negative effect on all the measures of financial performance used in the study. The study finally concludes that restriction that is made on financial flexibility through the use of debt ultimately exerts an unfavourable impact on the financial performance of Indian companies. Besides, the study recommends that Indian companies maintain a low

24  Capital structure and corporate performance leverage ratio because interest rate burden on managers may bring down the level of confidence of investors in the debt market out of fear of higher interest burden on managers in the future, which reduces the shareholders’ value. Moreover, the researchers also advise Indian investors to invest in low leverage firms. At the same time, Boodhoo (2009) studies the determinants of capital structure and the way the use of debt capital impacts the financial performance of companies. The study based on its objectives uses the accounting data of a sample consisting of 40 Mauritian companies listed on the Stock Exchange of Mauritius. The study chooses companies from six different industries from the Mauritian economy. Based on the findings, the study infers that use of debt up to a certain threshold negatively affects companies’ financial performance and after that level the tax deductibility of debt interest outweighs the cost of financial distress arising out of the use of debt and ultimately exerts a positive impact on the financial performance of Mauritian companies. Therefore, the study documents a non-linear relationship between capital structure and the financial performance of the sample companies. Another concurrent study by El-Sayed Ebaid (2009) investigates the relationship between capital structure choices made by non-financial listed Egyptian companies and their performance for the period of 1997–2005. The study employs multiple regression analysis to explore the statistical association between the variables. The study finally concludes that capital structure choices by the firms is sometimes either weakly related or may not be related to their performance. Considering the relationship between capital structure and firm performance as an unresolved issue in Nigeria, David and Olorunfemi (2010) make a serious attempt to analyse the nexus in the context of the Nigerian petroleum industry for the period of 1999–2005. The study introduces debt-equity ratio and EPS as a measure of leverage and performance respectively. It also introduces dividend per share as another dependent variable to test the effect of leverage on dividend payouts. The study, using panel data regression analysis, including fixed effect, random effect and maximum likelihood estimation, documents a positive impact of leverage ratio on the financial performance and dividend per share of Nigerian petroleum companies. The study based on its findings suggests that Nigerian petroleum companies increase the degree of leverage through the use of debt in the capital structure to strive and gain benefits out of it. Moreover, Margaritis and Psillaki (2010) carry out a popular research investigation on the effect of leverage on firm performance across varied industries by using a sample consisting of French manufacturing companies. The study endorses the agency cost theory developed by Jensen and Meckling (1976) and shows how firms’ efficiency is improved over the period of investigation with an increased degree of leverage. Furthermore, San and Heng (2011) investigate the relationship between capital structure and financial performance of 49 construction companies listed on the Main Board of Bursa, Malaysia, before and during the 2007 financial crisis. The study classifies the sample companies into big, medium and small-sized companies and uses financial data for the period of 2005–2008. The study introduces a number of variables like long-term debt to capital ratio, debt to equity ratio, debt to capital ratio, etc., to represent the capital structure of such Malaysian companies. Besides, the financial

Capital structure and corporate performance  25 performance of the companies is measured by ROCE, ROE, operating margin and a few other variables. Using the ordinary least squares model, the study documents that for big companies ROCE has a significant and positive relationship with capital structure measured by debt to equity market value. EPS has a positive relationship with long-term debt to capital ratio and an inverse relationship with debt to capital ratio. For medium companies, operating margin and the ratio of long-term debt to common equity are found to have a positive statistical relationship. Finally, for small companies, EPS is found to be negatively associated with debt to capital ratio. At last, the study admits that as the accounting policies and other aspects like annual closing of accounts are different among the sample companies so the accuracy of the results is hampered. Besides, according to the researchers, a time-series analysis considering a long study period and inclusion of some other suitable variables of capital structure may produce more concrete findings. In another notable empirical inquiry in the context of Germany, Stiglbauer (2011) considers a sample of 80 companies that are listed in the HDAX index of Deutsche Borse Group. The study introduces debt ratio to represent leverage and a set of dependent variables as measures of a company’s performance such as ROA, ROE, MBVR, etc. Applying content analysis and simultaneous equation analysis the study suggests a statistically positive relationship between the degree of leverage maintained by the companies and financial performance measured by the MBVR. The study concludes with the view that capital structure is one of the crucial corporate governance factors towards the financial performance of HDAX listed companies in Germany. Besides, using a sample consisting of 36 blue-chip companies listed on the Baltic stock exchanges for the period of 2007–2010, Bistrova et al. (2011) make an empirical inquiry into the impact of capital structure choices on the profitability represented by ROA and ROE. The study based on its findings confirms that for companies operating in the Baltic countries, the lower the leverage the higher is the profitability. In this regard, the study endorses the proposition of pecking order theory, which says that a firm should preferably rely on equity capital, i.e. self-generated funds. Yet again, Pratheepkanth (2011) in the context of Sri Lanka examines the capital structure- financial performance nexus considering the companies that are listed and traded on the Colombo Stock Exchange for a period of five years from 2005 to 2009. The study through correlation and regression estimations finds that capital structure has a significantly adverse effect on the financial performance measured by return on investment (ROI) and ROA of the sampled companies. However, a weak positive correlation between capital structure and gross profit is evidenced in the correlation analysis. Finally, the study concludes that Sri Lankan companies mostly rely on debt capital, which is detrimental to their profitability. After a year, Sharma (2012) tries to interlink leverage with the value of the firm in the context of companies from the Indian pharmaceutical industry. The study uses a sample that consists of 12 pharmaceutical companies that are listed on the National Stock Exchange (NSE) of India from 2005 to 2011. The companies are chosen by considering their volume of market capitalization as of 1st April 2005. The study finally documents that the magnitude of financial leverage

26  Capital structure and corporate performance of Indian pharmaceutical companies does not significantly affect their overall cost of capital. The financial leverage of firms is also not found to affect their market value. Likewise, Kar (2012) makes a cross-country investigation to explore the relevance of capital structure towards profitability and a few other non-financial measures of performance of 782 microfinance institutions chosen from 92 countries for the period 2000–2007. The study employs GMM and IV estimations along with instruments to establish the statistical association between the set of dependent and independent variable(s). Finally, the study in line with agency theory finds that increasing leverage among the firms brings profit efficiency while decreasing leverage causes a lowering of cost efficiency. Regarding other measures of performance, the study does not find any evidence of the impact of capital structure on the breadth of outreach and increase in women’s participation as loan clients for microfinance institutions. In the concurrent period, Pouraghajan et al. (2012) make an attempt to provide some empirical insights on the effect of capital structure when measured by debt ratio on the financial performance of 80 firms listed on the Tehran Stock Exchange (TSE). The study is carried out for the period of 2006–2010 and sample companies are chosen from 12 industries. The study using correlation and regression analysis suggests a significantly negative relationship between capital structure and accounting performance of Iranian firms measured by ROA and ROE. The study based on the findings suggests that debt needs to be considered as a crucial factor towards determining financial performance and given that during the considered study period the mean debt ratio of the firms is more than 65 percent, Iranian firms may need to think of lowering their leverage ratio to improve financial performance. Similarly, Norvaisiene (2012) examines how capital structure is related to the performance of Baltic firms for the period of 2002–2011. The study based on its findings concludes that an increasing level of financial indebtedness negatively affects the profitability of companies from Baltic countries. The study also documents that the role of debt towards efficiency in asset management is quite ambiguous and it is negatively related to capital asset turnover and also total asset turnover of the sampled companies. Moreover, Jiraporn et al. (2012) in their empirical investigation document an interesting observation that the effect of changes in the capital structure of companies on financial performance is moderated by the dominance or power of the Chief Executive Officer (CEO). The study suggests the capital structure to be inversely related to the financial performance of companies with a powerful CEO. It is observed that the dominant effect of powerful CEO intensifies the agency problem, which leads to lower firm value. Furthermore, Gardner et al. (2012) in the context of Malaysia examine the effect of leverage on firm performance as a part of their research. The study uses 82 companies that are listed on the Malaysian ACE Market for the period of 2007–2009. Using correlation and multiple regressions estimations the researchers find a positive relationship between leverage and firm performance measured by Tobin’s Q ratio. Additionally, Akinlo and Asaolu (2012) investigate the impact of leverage on the profitability of Nigerian firms. The study considers a sample of 66 non-financial

Capital structure and corporate performance  27 firms purposively chosen from the listed firms of the Nigerian Stock Exchange for the period of 1999–2007. The firms chosen in the sample belong to 15 different industries from the Nigerian economy. The study uses chi-square test including panel data regression estimation and finds leverage to have a negative impact on the profitability of the sample firms. The study suggests that the Nigerian firms reduce their debt ratio, i.e. use of debt capital, to improve profitability. Again, Memon et al. (2012) focus on the textiles sector to understand the statistical association between capital structure and corporate financial performance. The researchers choose 141 textile companies from Pakistan and analyse balance sheet analysis (BSA) data. BSA is a document that was issued by the State Bank of Pakistan from 2004 to 2009. The study by applying the log-linear regression model arrives at the conclusion that the firms from the textile sector of the country failed to choose a judicious mix of debt and equity and therefore they are operating with a non-optimum level of capital structure, which leads to poor financial performance. Based on the findings, the researchers suggest that corporate managers and financial analysts seriously involve themselves in designing the optimum capital structure. Moreover, Abu-Rub (2012) looks into the effect of leverage on the financial performance of 28 companies listed on the Palestine Stock Exchange during 2006 to 2010. The study finds the capital structure of the Palestine firms to exert a favourable influence on their financial performance. Likewise, Pratt (2012) makes a stringent analysis on the relevance of capital structure towards the valuation of a firm considering a long time frame, i.e. from 1970 to 2010. The study suggests an unfavourable impact of leverage on firm value. The study observes that after the Tax Reform Act of 1986 the interest tax shield value declines considerably, which results in a negative impact of the use of debt on firm market valuation. Finally, the findings of this study go against the trade-off theory and suggest that firms remain underleveraged to retain market value. Another contemporary study by Soumadi and Hayajneh (2012) in the context of 76 Jordanian firms including 53 industrial and 23 service corporation for the period of 2001–2006 finds that there is no such significant difference in financial performance between two sets of firms, one having high financial leverage and the other having low financial leverage. However, specifically measuring the effect of financial leverage on performance and value of the sampled companies, the study finds a statistically significant and negative impact when they are measured by ROE and Tobin’s Q respectively. In a quite similar attempt, an empirical study by Muritala (2012) tries to explore the relationship between capital structure and performance for a sample consisting of ten manufacturing companies quoted on the Nigerian Stock Exchange for the period of 2000–2010. The study confirms a statistically significant and negative impact of the use of debt on the performance measure ROA of the sample companies. Subsequently, Nazir and Saita (2013) in the context of Pakistan make an attempt to examine the effect of capital structure or leverage on the agency cost of companies. The study considers a sample consisting of 265 non-financial companies that are listed on the Karachi Stock Exchange from 2004 to 2009. The study uses

28  Capital structure and corporate performance general & administrative expenses to sales ratio to measure the agency cost which arises out of the conflict of interest between management and shareholders. The study applies both pool and panel data regression analyses and finds that almost all the proxies used for leverage significantly affect the agency cost of Pakistani companies measured by general & administrative expenses to sales ratio. The study finally endorses the existing view on the role of debt as a disciplinary device for lowering managerial discretionary expenses and improving firm performance. The study finally admits its limitations and accepts the fact that agency cost may also be affected by a set of other factors that may include ownership structure and concentration, board size of the companies, etc. Besides, the empirical investigation of Chisti et al. (2013) tries to establish the interrelationship between capital structure variables like debt to equity ratio, debt to assets ratio, etc., on the profitability in the context of automobile companies in India for the period of 2007–2008 to 2011–2012. The study simply uses a correlation matrix to test the relationship and finds the debt-equity ratio to have a statistically significant and negative correlation with the profitability of the sampled firms. Interestingly, another measure of capital structure, i.e. debt to assets ratio, is seen to be positively associated with profitability. Besides, the study also evidences that the interest coverage ratio is positively correlated with the measure of profitability. One of the famous empirical investigations on the effect of leverage on the financial performance of companies is carried out by Gonzalez (2013). The study makes a very comprehensive approach to establish the empirical relationship through a cross-country analysis of 10,375 firms selected from 39 countries. The study applies the widely recognized GMM estimation, which is suitable for dynamic panel data analysis developed by Arellano and Bond (1991). The study finds a negative impact of leverage on the operating performance of the sample firms due to the fact that the cost of increased financial distress arising out of increased debt outweighs the benefits of debt as a controlling instrument towards managerial opportunistic activities. Besides, one of the crucial findings of the study is that the actual impact of leverage on the operating performance of the concerned firm is significantly dependent on the legal origin and other factors like the financial structure and development of the respective country. In this regard, companies that belong to French civil law countries are found to reveal a favourable impact of leverage on operating performance in a situation when the industry is in a downturn. Finally, the study concludes that the dominance between the financial distress effect and controlling effect in regard to the use of debt is associated with the above-mentioned factors. Again, Adewale and Ajibola (2013) analyse the impact of capital structure on firm performance in the context of some selected manufacturing companies of Nigeria. Considering a study period of 11 years, i.e. from 2002 to 2012, and applying panel least squares estimation, the study finds a statistically positive effect of debt ratio on the performance of Nigerian companies measured by ROI and ROE. Concurrently, Olokoyo (2013) inquires into the empirical relationship between capital structure and financial performance in the context of Nigeria, taking a sample of 101 non-financial companies chosen from 26 subsectors. The study

Capital structure and corporate performance  29 introduces a number of variables like ROI, ROA and ROE to proxy accounting performance. Besides, the study also introduces P/E ratio and Tobin’s Q to measure market performance. The study applies panel data regression estimation to establish the relationship between the set of dependent and independent variables. Applying the panel data regression analysis, the study finally documents a significant and negative relationship between leverage measured by total debt to total assets (TDTA) ratio and accounting performance of Nigerian companies. However, a favourable impact of financial leverage on the market performance is observed in the study. The study based on its contradictory findings between accounting and market performance measures suggests that Nigerian companies focus on their real operational efficiency to match the accounting performance with market valuation of their shares. Goyal (2013) investigates the actual empirical association between capital structure and profitability in the context of the NSE listed public sector banks of India. The study considers a period of five years, i.e. from 2008 to 2012, and uses short-term debt to capital, long-term debt to capital and total debt to capital ratio as proxies of capital structure. To represent the profitability of public sector banks, the study introduces ROA, ROE and EPS. The regression results suggest a significantly positive impact of capital structure when measured by short-term debt to capital on all the measures of the bank’s profitability. Besides, the other two proxies of capital structure are found to have a negative effect on the profitability of Indian public sector banks. Finally, the study recommends future research directions where it gives importance to the consideration of a longer study period, to the use of a more broad sample and on doing a comparative analysis between domestic and foreign banks to have a more valid and comprehensive picture on the issue. Again, Boroujeni et al. (2013) examine the relevance of capital structure towards firm performance in the context of Iran. The study constructs a sample of 123 non-financial and non-investment companies listed and traded on the TSE of Iran for the period of 2001–2008. The study uses TDTA ratio as a measure of leverage to represent capital structure. Besides, the study represents firm performance by ROA. The study applies multivariable regression estimation along with the test of normality, autocorrelation and variance homogeneity. Based on the results obtained, the study infers that capital structure has a significant and positive relationship with the financial performance of Iranian companies. Moreover, Chung et al. (2013) make an attempt to examine the relevance of capital structure policy for firms towards their survival in the market. The study considers oil exploration firms and uses panel data estimation technique. According to the findings of the study, capital structure does not bear much linkage with the survival probability of firms. Moreover, the study also disapproves the idea of an optimum capital structure and supports the irrelevance approach of capital structure. Again, Thomas (2013) examines the capital structure-performance relationship in the context of 21 Indian cement companies for the period of 2003–2004 to 2007–2008. The study presents the movement of total leverage and EPS over the years and concludes that the EPS is increasing over the considered time period with decreasing total leverage.

30  Capital structure and corporate performance Besides, Park and Jang (2013) consider the need for a comprehensive study on the interrelationship among leverage, free cash flow, diversification of companies and financial performance of firms. The study analyses data of 308 restaurant companies for the period of 1995–2008. Using two-stage least squares and three-stage least squares regression estimation techniques the study finds that free cash flow causes an increase in both related and unrelated types of diversification entropies. The study also confirms that the debt can be sensibly used as an effective instrument to limit the managerial discretions in using the free cash flow and to improve a firm’s financial performance. Another study by Iavorskyi (2013) examines the effect of capital structure on firm performance in the context of the Ukraine market for the period of 2001–2010. The study confirms that the relation between debt financing and company’s financial performance is negative and for Ukraine companies the free cash flow theory or trade-off theory of capital structure does not hold good; rather, pecking order theory is more applicable for these companies. As part of an empirical investigation, Brendea (2014) analyses the effect of capital structure on the financial performance of listed Romanian firms for the period of 2007–2011. The study considers ROA to proxy the performance of the companies. Besides, it uses the debt ratio as a measure of capital structure. Finally, using the Arellano and Bond (1991) model for dynamic panel data estimation, the study suggests an unfavourable impact of the use of debt in the capital structure on the financial performance of the firms when measured by ROA. Based on the findings, the study endorses the ‘new pecking order theory’ in line with Chen (2004). Further, Javeed and Azeem (2014) make an attempt to unveil the dubious relationship between capital structure and firm value, taking a sample of 155 non-financial companies listed at the Karachi Stock Exchange from 2008 to 2012. By employing the fixed effect regression method on the balanced panel data the study suggests a positive impact of capital structure or magnitude of leverage measured by TDTA on Tobin’s Q. Again, Agnihotri (2014) makes an important investigation on how the capital structure decision and overall cost of capital depend on the corporate strategy that a firm is pursuing. The study finds that a firm should finance its lowcost and unrelated diversification strategies through debt as it would lower the overall cost of capital of the firm. However, when a firm pursues a risky strategy like differentiation and innovation then it should finance them by issuing equity capital to maintain the cost of capital at its minimum level. Finally, the study suggests that the nature of funding would depend on the industry growth in the case when the firm is pursuing a hybrid and related diversification strategy. According to the study, when the industry in going through a volatile condition it would be better to rely on equity financing under a hybrid and related diversification strategy. However, for mature industries, debt financing is supposed to lower the overall cost of capital. Yet again, Loncan and Caldeira (2014) work on establishing the interrelationship among capital structure of firms, cash holdings and financial performance. The study constructs a sample considering all the non-financial companies that are listed and traded on the Sao Paulo Stock Exchange of Brazil for the period of 2002– 2012. The study employs the fixed effect estimation under panel data regression

Capital structure and corporate performance  31 analysis to establish the desired relationship. The study finally documents cash holdings to be negatively related to both short- and long-term debt. Regarding the relationship between capital structure and firm value, the study suggests a significant and inverse relationship between both the forms of debt and the value of Brazilian firms. Besides, Ismail (2014) in an empirical inquiry in the context of Malaysia attempts to establish the statistical association between leverage, size of firm and financial performance. The study considers a sample of 245 Main Board listed companies for the period of 1999–2002 representing the post-economic crisis period. The study uses the total debt to total equity ratio as a measure of leverage. The study applying panel pool regression estimation finds no evidence on any statistical association between leverage and value of Malaysian companies measured by EVA. Similarly, Banerjee and De (2014) examine whether the capital structure is a significant determinant of firm profitability in the context of the steel and iron industry in India. The study constructs a sample of 130 Indian iron and steel companies listed and traded in the Bombay Stock Exchange (BSE) and NSE of India for the period of 1999–2000 to 2010–2011. The study based on multiple regression analysis suggests that leverage negatively affects the profitability of Indian iron and steel companies both in the pre-recession and in the post-recession period. Therefore, capital structure is found to be an important determinant of profitability for the companies that belong to the iron and steel industry of India. The effect of capital structure on the financial performance is examined by Hasan et al. (2014) in the context of Bangladesh. The study considers 36 Bangladeshi companies listed on the Dhaka Stock Exchange for the period 2007–2012. The study introduces EPS, ROE and ROA, Tobin’s Q as dependent variables to measure firm performance. The study based on pooled panel data estimation technique confirms that EPS has a significant and positive relationship with SDTA ratio. The study also documents the significant and negative relationship between capital structure and financial performance measured by ROA. However, the study does not provide any evidence of a significant association between capital structure and financial performance measured by ROE and Tobin’s Q. Furthermore, Mwangi et al. (2014) explore the empirical association between capital structure and firm performance measured by ROA and ROE. The study uses a sample of 42 non-financial companies that are listed and traded on the Nairobi Securities Exchange (NSE) of Kenya for the period of 2006–2012. Based on the results obtained from the feasible generalized least squares regression estimation, the study documents a statistically significant and negative association between capital structure and financial performance measured by both ROA and ROE of Kenyan non-financial companies. Based on the findings of the study, the researchers recommend that Kenyan corporate managers reduce their reliance on long-term debt capital as a source of finance. Amara and Aziz (2014) in the context of Pakistan make an attempt to interlink capital structure with the firm performance of 33 companies from the food sector that are listed on the Karachi Stock Exchange of Pakistan. The study considers

32  Capital structure and corporate performance debt to equity ratio, SDTA ratio and LDTA ratio to represent capital structure of the sample companies. Regarding firm performance, the study introduces EPS and ROA. The study applies Prais-Winsten regression estimation after testing heteroskedasticity, multicollinearity, contemporaneousness and autocorrelation. Based on the results, the study documents a statistically significant and negative impact of debt to equity ratio on the financial performance of the sample companies. However, the relationship between performance and the other two measures of capital structure is found to be statistically insignificant. Based on the study results, the researchers conclude that the food companies in Pakistan need to find an optimum debt-equity mix to maximize their financial performance. The study endorses the static trade-off theory of capital structure. Vatavu (2015) examines the impact of debt on the financial performance of 196 Romanian manufacturing firms listed on the Bucharest Stock Exchange over a period of eight years from 2003 to 2010. The study observes that the sampled firms are performing well when they are using equity capital instead of issuing debt. Therefore, the study actually finds an inverse relationship between the magnitude of leverage and financial performance of firms. Later on, Nassar (2016) tries to produce some empirical evidence on the effect of capital structure on financial performance in the context of Turkey. The study uses the financial statements of 136 companies listed on the Istanbul Stock Exchange for the period of 2005–2012. The study uses TDTA ratio as a proxy of capital structure and ROA, ROE and EPS as the measures of financial performance. Using multivariate regression analysis, the study suggests that capital structure has a significant and negative effect on all three measures of financial performance of the sample companies. Finally, the study suggests further empirical investigation including business risk and sales growth of the companies. As per the researcher, a comparative study on large and small companies may also be very useful to draw meaningful inferences. Concurrently, the study of Awais et al. (2016) uses a sample of 69 non-financial companies listed and traded on the Karachi Stock Exchange of Pakistan during the period of 2004–2012. The study considers the TDTA, SDTA and LDTA ratios as measures of capital structure. Besides, ROA, ROE, EPS and Tobin’s Q are used to measured corporate performance. Finally, based on regression analysis using STATA, the study documents a negative relationship between the measures of capital structure and performance of Pakistani non-financial companies. Again, Chadha and Sharma (2016) use a sample of 422 Indian manufacturing companies that are listed and traded on the BSE for a period of ten years, i.e. 2003–2004 to 2012–2013. The study applies ratio analysis and panel data regression estimation to show the trend of capital structure and to establish the relationship between the variables. The study based on its data analysis demonstrates that Indian manufacturing firms hold substantial debt in their capital structure and companies are seen to be inclined towards the use of debt capital to finance their assets and operations. Notably, the study using fixed effect estimation under panel data analysis does not find evidence of any significant relationship between leverage and firm value in the context of Indian manufacturing firms.

Capital structure and corporate performance  33 The empirical inquiry of Mouna et al. (2017) represents a serious attempt to analyse the statistical relationship between leverage and corporate performance in the context of 53 Moroccan companies for the period of 2014–2016. The study uses total liabilities to total assets ratio and total liabilities to total equity ratio to represent leverage. Based on panel data regression analysis, the study documents a significant and negative impact of leverage on the profitability measured by ROA and ROE of the sampled firms. The researchers based on the findings of the study reject the trade-off hypothesis and support the pecking order hypothesis and consequently suggest that Moroccan companies rely more on equity capital and less on externally borrowed funds. Another recent past study by Ameen and Shahzadi (2017) examines the impact of capital structure on the profitability of cement companies in Pakistan. A sample consisting of 18 cement companies listed on the Karachi Stock Exchange for the period of 2006–2015 has been selected for the analysis. Debt ratio, i.e. total liability to total assets ratio, and long-term debt to assets ratio are found to have a statistically negative effect on ROA and ROE. Besides, the SDTA ratio is found to be positively related to ROE. Also, Bortych (2017) examines the impact of capital structure on the corporate performance of Dutch companies. The study tries to find the difference in the results between private and public companies. It employs fixed effect regression model to arrive at the results and finally finds that capital structure impacts the performance of the sampled private companies significantly and positively. However, the use of long-term debt is found to be negatively associated with the performance measured by ROA of such firms. According to the researcher, this may be due to the underinvestment effect and high flotation cost. On the other hand, in case of public companies, capital structure is found to positively impact firm performance. Notably, the study finds short-term debt to have a negative impact on the ROA of public companies. Moreover, Pandey and Sahu (2017a) make an empirical examination of how capital structure affects firm performance and value. The study constructs a sample of 56 manufacturing companies listed and traded on BSE 200 index of BSE of India for the period of 2011–2016. The study uses the debt-equity ratio to measure the financial leverage of the sample firms. Besides, to measure firm performance the study uses ROE and to represent firm market value the study introduces Tobin’s Q. The results of the fixed effect model under panel data estimation suggest a statistically significant and negative effect of financial leverage on the performance and valuation of Indian manufacturing firms. The study based on its findings suggests Indian corporate managers to consider the decision on capital structuring a crucial and challenging one and to maintain the degree of financial leverage at a possibly low level to prevent deterioration in financial performance. Nenu et al. (2018) examine the relationship between leverage and corporate performance in the context of listed companies of the Bucharest Stock Exchange for the period of 2000–2016. Applying the two-step system GMM method, the study documents a statistically significant and positive relationship of leverage with share price volatility. Besides, the study also finds that firm profitability is negatively associated with both the short-term and the long-term debt ratio. In addition to this, Ibhagui and Olokoyo (2018) carry out an esteemed research on

34  Capital structure and corporate performance how the degree of leverage affects corporate performance and value and whether this effect is moderated by firm size. The researcher uses a sample of 101 listed firms from the Nigeria market between 2003 and 2007 to construct a panel data set. The study explores a very important and crucial fact regarding the leverageperformance relationship. It shows that leverage is negatively related with the performance of Nigerian firms and the effect of leverage on performance is contingent on firm size as expected. The unfavourable impact of leverage on performance is much prominent for small-sized firms and the severity of the negative effect diminishes with an increase in firm size. Most recently, the effect of leverage on corporate financial performance was tested by Ganiyu et al. (2019) through dynamic panel data analysis of 115 nonfinancial listed firms from Nigeria. The study interestingly documents a non-linear effect of debt capital on the performance of the sampled firms. More specifically, the study finds that debt capital positively impacts firm performance at its moderate level but when excessive debt is used, the effect turns to be negative. Another most recent empirical study by Singh and Bagga (2019) examines the statistical association between capital structure and the profitability of Nifty 50 companies listed and traded on the NSE of India from 2008 to 2017. The researchers introduce the debtequity ratio to proxy capital structure and ROA & ROE to represent firms’ profitability. The study adopts panel data regression estimation and establishes a positive relationship between capital structure and the profitability of NSE listed firms. An interesting finding relating to the role of debt capital in moderating the relationship between overinvestment and firm performance is reported in the study of Trong and Nguyen (2020) on 669 non-financial Vietnamese listed companies for the period of 2008–2018. The research shows that overinvestment negatively affects firm performance of Vietnamese listed companies and interestingly in such situations the use of debt capital limits excessive cash flow and thereby restrains ineffective investments and lessens the negative effect of overinvestment on firm performance. Now, debt is not only supposed to reduce overinvestment but it is also argued to create underinvestment problem due to the over-restrictions imposed on management due to fixed payment obligations (Myers, 1977; Stulz, 1990). However, a recent study by Bhat et al. (2020) in the context of China validates that short-term debt capital can help enterprises to take a flexible financing decision, allowing them to avail cost-effective debt by repricing and renegotiation of debt contracts where there are growth opportunities. It is also observed that short-term debt can reduce the problem of underinvestment. A recent attempt by Abdullah and Tursoy (2021) in the context of Germany documents a very interesting evidence on the effect of capital structure on the performance of non-financial firms. The study finds debt to contribute positively towards firm performance and refers to the lower cost associated with the issue of debt than equity in the German market and the tax shield benefit as two plausible reasons behind such findings. The researchers also report another interesting evidence that the relationship between capital structure and firm performance is weakened with the adoption of International Financial Reporting Standards (IFRS) by the firms.

Capital structure and corporate performance  35 Concluding remarks From the rigorous review of the existing literature developed on the relationship between capital structure and corporate performance, it can be stated that innumerable research studies have been carried out in this direction in different countries across the world. However, the pattern of relationship between the variables is found to be different for different country perspectives and time frame of the studies. So, it is true that we finally reach an inconclusive state wherein the relationship between these two variables cannot be generalised. In fact, it is better to say that the relationship between these variables is highly contingent on factors like economic perspective, time period considered for the study, methodology adopted, etc. References Abdullah, H., & Tursoy, T. (2021). Capital structure and firm performance: evidence of Germany under IFRS adoption. Review of Managerial Science, 15(2), 379–398. Abor, J. (2005). The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana. The Journal of Risk Finance, 6(5), 438–445. Abor, J. (2007). Debt policy and performance of SMEs: evidence from Ghanaian and South African firms. The Journal of Risk Finance, 8(4), 364–379. Abu-Rub, N. (2012). Capital structure and firm performance: evidence from Palestine stock exchange. Journal of Money, Investment and Banking, 23(1), 109–117. Adewale, M. T., & Ajibola, O. B. (2013). Does capital structure enhance firm performance? Evidence from Nigeria. IUP Journal of Accounting Research & Audit Practices, 12(4), 43–55. Agnihotri, A. (2014). Impact of strategy–capital structure on firms’ overall financial performance. Strategic Change, 23(1–2), 15–20. Agrawal, A., & Knoeber, C. R. (1996). Firm performance and mechanisms to control agency problems between managers and shareholders. Journal of Financial and Quantitative Analysis, 31(3), 377–397. Akinlo, O., & Asaolu, T. (2012). Profitability and leverage: evidence from Nigerian firms. Global Journal of Business Research, 6(1), 17–25. Altaf, N., & Shah, F. A. (2018). Ownership concentration and firm performance in Indian firms: does investor protection quality matter? Journal of Indian Business Research, 10(1), 33–52. Amara, L. F., & Aziz, B. (2014). Impact of capital structure on firm performance: analysis of food sector listed on Karachi Stock Exchange. International Journal of Multidisciplinary Consortium, 1(1), 1–11. Ameen, A., & Shahzadi, K. (2017). Impact of capital structure on firms profitability: evidence from cement sector of Pakistan. Research Journal of Finance and Accounting, 8(7), 29–34. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. Armstrong, M. and Baron, A. (1998). Performance management: the new realities. London: Institute of Personnel Development. Awais, M., Iqbal, W., Iqbal, T., & Khursheed, A. (2016). Impact of capital structure on the firm performance: comprehensive study of Karachi Stock Exchange. Science ­International, 28(1), 501–507.

36  Capital structure and corporate performance Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of ­Finance, 57(1), 1–32. Banerjee, A., & De, A. (2014). Determinants of corporate financial performance relating to capital structure decisions in Indian iron and steel industry: an empirical study. Paradigm, 18(1), 35–50. Barry, M. J. (1997). Why do firms change their capital structure? Doctoral Dissertation, Boston College, The Carroll Graduate School of Management, Massachusetts, United States. Berle, A. A., & Means, G. C. (1932). The modern corporation and private property. New Brunswick. NJ: Transaction. Bhat, K. U., Chen, S., Chen, Y., & Jebran, K. (2020). Debt capacity, debt choice, and underinvestment problem: evidence from China. Economic Research, 33(1), 267–287. Bistrova, J., Lace, N., & Peleckienė, V. (2011). The influence of capital structure on Baltic corporate performance. Journal of Business Economics and Management, 12(4), 655–669. Blanchard, O. J., Lopez-de-Silanes, F., & Shleifer, A. (1994). What do firms do with cash windfalls? Journal of Financial Economics, 36(3), 337–360. Boodhoo, R. (2009). Capital structure and performance of Mauritius listed firms: Theoretical and empirical evidences. Online Web. Available at: http:// www.nyu.edu/pages/classes/ keefer/EvergreenEnergy/boodhoorebook.pdf. Boroujeni, H. N., Noroozi, M., Nadem, M., & Chadegani, A. A. (2013). The impact of capital structure and ownership structure on firm performance: a case study of Iranian companies. Research Journal of Applied Sciences, Engineering & Technology, 6(22), 4265–4270. Bortych, N. (2017). Capital structure influence on firm’s financial performance: differences in public and private firms, evidence from the Netherlands. 9th IBA Bachelor Thesis Conference, July 5th, 2017, Enschede, The Netherlands. Brendea, G. (2014). Ownership structure, performance and capital structure of Romanian firms. Internal Auditing and Risk Management, 36(1), 1–9. Campello, M. (2006). Debt financing: does it boost or hurt firm performance in product markets? Journal of Financial Economics, 82(1), 135–172. Chadha, S., & Sharma, A. K. (2016). An empirical study on capital structure in Indian manufacturing sector. Global Business Review, 17(2), 411–424. Chen, J. J. (2004). Determinants of capital structure of Chinese-listed companies. Journal of Business Research, 57(12), 1341–1351. Chisti, K. A., Ali, K., & Sangmi, M. I. D. (2013). Impact of capital structure on profitability of listed companies (evidence from India). The USV Annals of Economics and Public Administration, 13(1 (17)), 183–191. Chung, Y. P., Na, H. S., & Smith, R. (2013). How important is capital structure policy to firm survival? Journal of Corporate Finance, 22, 83–103. David, D. F., & Olorunfemi, S. (2010). Capital structure and corporate performance in Nigeria petroleum industry: panel data analysis. Journal of Mathematics and Statistics, 6(2), 168–173. Durand, D. (1952). Costs of debt and equity funds for business: trends and problems of measurement. Conference on research in business finance, National Bureau of Economic Research, 215–262. El-Sayed Ebaid, I. (2009). The impact of capital-structure choice on firm performance: empirical evidence from Egypt. The Journal of Risk Finance, 10(5), 477–487. Ganiyu, Y. O., Adelopo, I., Rodionova, Y., & Samuel, O. L. (2019). Capital structure and firm performance in Nigeria. African Journal of Economic Review, 7(1), 31–56.

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38  Capital structure and corporate performance Loncan, T. R., & Caldeira, J. F. (2014). Capital structure, cash holdings and firm value: a study of Brazilian listed firms. Revista Contabilidade & Financas, 25(64), 46–59. Mahakud, J., & Misra, A. K. (2009). Effect of leverage and adjustment costs on corporate performance. Journal of Management Research, 9(1), 35–42. Margaritis, D., & Psillaki, M. (2010). Capital structure, equity ownership and firm performance. Journal of Banking & Finance, 34(3), 621–632. Memon, F., Bhutto, N. A., & Abbas, G. (2012). Capital structure and firm performance: a case of textile sector of Pakistan. Asian Journal of Business and Management Sciences, 1(9), 9–15. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48, 261–297. Mouna, A., Jianmu, Y., Havidz, S. A. H., & Ali, H. (2017). The impact of capital structure on Firms performance in Morocco. International Journal of Application or Innovation in Engineering & Management, 6(10), 11–16. Muritala, T. A. (2012). An empirical analysis of capital structure on firms’ performance in Nigeria. International Journal of Advances in Management and Economic, 1(5), 116–124. Mwangi, L. W., Makau, M. S., & Kosimbei, G. (2014). Relationship between capital structure and performance of non-financial companies listed in the Nairobi Securities Exchange, Kenya. Global Journal of Contemporary Research in Accounting, Auditing and Business Ethics, 1(2), 72–90. Myers, S. C. (1977). The determinants of corporate borrowings. Journal of Financial ­Economics, 5(2), 147–175. Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221. Nassar, S. (2016). The impact of capital structure on Financial Performance of the firms: evidence from Borsa Istanbul. Journal of Business & Financial Affairs, 5(2), 1–4. Nazir, S., & Saita, H. K. (2013). Financial leverage and agency cost: an empirical evidence of Pakistan. International Journal of Innovative and Applied Finance, 1(1), 1–16. Nenu, E., Vintila, G., & Gherghina, S. (2018). The impact of capital structure on risk and firm performance: empirical evidence for the Bucharest stock exchange listed companies. International Journal of Financial Studies, 6(2), 41. Norvaisiene, R. (2012). The impact of capital structure on the performance efficiency of Baltic listed companies. Engineering Economics, 23(5), 505–516. Olokoyo, F. O. (2013). Capital structure and corporate performance of Nigerian quoted firms: a panel data approach. African Development Review, 25(3), 358–369. Pandey, K. D., & Sahu, T. N. (2017a). Financial leverage, firm performance and value: with reference to Indian manufacturing firms. Asian Journal of Research in Banking and Finance, 7(7), 265–274. Pandey, K. D., & Sahu, T. N. (2017b). An empirical analysis on capital structure, ownership structure and firm performance: evidence from India. Indian Journal of Commerce and Management Studies, 8(2), 63–72. Pandey, K. D., & Sahu, T. N. (2019a). Concentrated promoters’ ownership and firm value: re-examining the monitoring and expropriation hypothesis. Paradigm, 23(1), 70–82. Pandey, K. D., & Sahu, T. N. (2019b). Debt financing, agency cost and firm performance: evidence from India. Vision, 23(2), 267–274. Park, K., & Jang, S. S. (2013). Capital structure, free cash flow, diversification and firm performance: a holistic analysis. International Journal of Hospitality Management, 33, 51–63.

Capital structure and corporate performance  39 Pouraghajan, A., Malekian, E., Emamgholipour, M., Lotfollahpour, V., & Bagheri, M. M. (2012). The relationship between capital structure and firm performance evaluation measures: evidence from the Tehran Stock Exchange. International Journal of Business and Commerce, 1(9), 166–181. Pratheepkanth, P. (2011). Capital structure and financial performance: evidence from selected business companies in Colombo stock exchange Sri Lanka. Researchers World, 2(2), 171–183. Pratt, W. R. (2012). Is capital structure relevant? An empirical examination of capital structure choices, Doctoral dissertation, University of Texas–Pan American, United States. Rao, N. V., Al-Yahyaee, K. H. M., & Syed, L. A. (2007). Capital structure and financial performance: evidence from Oman. Indian Journal of Economics and Business, 6(1), 1–14. Ross, S. A., Westerfield, R. W., & Jaffe, J. (1996), Corporate Finance. 4th edition. New York: McGraw-Hill. San, O. T., & Heng, T. B. (2011). Capital structure and corporate performance of Malaysian construction sector. International Journal of Humanities and Social Science, 1(2), 28–36. Santos, J. B., & Brito, L. A. L. (2012). Toward a subjective measurement model for firm performance. Brazilian Administration Review, 9, 95–117. Sharma, K. (2012). Identifying relationship between capital structure and value of the firm for Indian pharmaceutical companies. Journal of Contemporary Management Research, 6(2), 77–85. Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737–783. Singh, N. P., & Bagga, M. (2019). The effect of capital structure on profitability: an empirical panel data study. Jindal Journal of Business Research, 8(1), 65–77. Singh, P., & Kumar, B. (2008). Trade off theory or pecking order theory: what explains the behavior of the Indian firms? Available at SSRN 1263226. Smith, A. (1776). The wealth of nation. Cannan edition. New York: Modern Library. Soumadi, M. M., & Hayajneh, O. S. (2012). Capital structure and corporate performance empirical study on the public Jordanian shareholdings firms listed in the Amman stock market. European Scientific Journal, 8(22), 173–189. Stiglbauer, M. (2011). Impact of capital and ownership structure on corporate governance and performance: evidence from an insider system. Problem and Perspective in Management, 9(1), 16–23. Stulz, R. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics, 26(1), 3–27. Thomas, A. E. (2013). Capital structure and financial performance of Indian cement industry. BVIMR Management Edge, 6(1), 44–50. Trong, N. N., & Nguyen, C. T. (2020). Firm performance: the moderation impact of debt and dividend policies on overinvestment. Journal of Asian Business and Economic Studies, 28(1), 47–63. Vatavu, S. (2015). The impact of capital structure on financial performance in Romanian listed companies. Procedia Economics and Finance, 32, 1314–1322. Wippern, R. F. (1966). Financial structure and the value of the firm. The Journal of Finance, 21(4), 615–633. Zeitun, R., & Tian, G. G. (2007). Capital structure and corporate performance: evidence from Jordan. Australasian Accounting, Business and Finance Journal, 1(4), 40–61.

3

Ownership structure The conceptual and empirical framework

Ownership structure: the conceptual aspects Theoretically, the ownership structure of a business corporation refers to the pattern of distribution of its ownership to different kinds of investors. It reflects the types of equity holders and their proportion of equity holdings. Conceptually, there may be different kinds of participants in the ownership of a publicly held company. Broadly classifying the types, we get four kinds of investors, such as promoters, financial institutions, the public and governments. The promoters may be domestic or foreign affiliates. The institutional investors include banks and non-banking financial institutions, mutual fund companies, insurance companies and many more. The shares of companies also go to the hand of common citizens, which are categorized as public shareholdings. Similarly, a certain fraction of ownership may also be held by the central or the state government(s). Below we have given a detailed description of the two prominent shareholding types in the Indian corporate sector: Promoters’ shareholding

Promoters as a kind of shareholder in business corporations could not find good space in the Indian Companies Act, 1956. However, the term promoter was explained under section 62 of the Companies Act, 1956. Companies Act, 1956, merely considers a promoter as an individual who has been recognized as a party in the preparation of the prospectus of the company. The Securities and Exchange Board of India (SEBI) also provides a description of various types of promoters in Indian companies. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, sees promoters as any persons who are in control of the issuer, instrumental in the formulation of a plan and whose names are mentioned in the offer document as so. Besides, SEBI’s Substantial Acquisition of Shares and Takeover Regulations, 1997, and Disclosure and Investment Protection Guidelines, 2000, have given special status to promoters. According to SEBI, promoters are also supposed to play a crucial role by rigorously monitoring and regulating corporate affairs by virtue of their ownership and managerial rights. DOI: 10.4324/9781003397878-3

Ownership structure: the conceptual and empirical framework  41 However, the newly drafted companies act of India, i.e. Companies Act, 2013, in its section 2(69) provides a comprehensive definition of the term ‘promoter’. According to the aforesaid act, a promoter may be any individual who has been identified as such in the prospectus of the company or in its annual return. Moreover, a person would be called a promoter when he or she holds either direct or indirect control over the management of affairs of the company as a shareholder or one of the directors or in other status. Again, a promoter is also supposed to provide business advice, directions or instructions to the Board of Directors (BoD) of the company. A promoter is supposed to have important functions and crucial duties for the concerned company since its inception to winding up. A promoter is a person who first dreams of the idea of a business corporation. Starting from envisioning the idea to make it a reality, a promoter has to bear all the tasks and hassle that come in between. Here we outline the following functions that a promoter has to usually undertake: • To decide and set the name of the company. • To propose the content and other aspects of the Articles of Association & Memorandum of Association of the company. • To propose the name of directors, bankers, auditors and many other important parties to the business. • To decide on the place of the registered and the head office of the company. • To prepare the prospectus and other crucial documents required for the incorporation of the company. Apart from these, the Companies Act, 2013, lays down certain aspects relating to the liabilities and rights of a promoter. Below we outline these aspects in a comprehensive manner: • Section 7(6) makes a promoter liable for furnishing any untrue information for the incorporation of the company. • Section 13(8) and section 27(2) enunciate about the obligation in allowing exit option to the dissenting shareholders. • Section 35(1) stipulates the liability of a promoter to pay compensation for any misstatement or omission in the prospectus caused by him or her. • Section 102(4) specifies the liability of promoters to compensate for any gain resulting arises out of non-disclosure or insufficient disclosure of information in explanatory statement. • Section 167(3) empowers promoters to appoint directors when all the existing directors are in vacation of office. • Similarly, section 168(3) gives power to promoters to appoint directors in case of resignation by all the existing directors. • Section 257(3) specifies the promoters’ duty to appear before the meeting of the creditors’ committee if so instructed by the interim administrator.

42  Ownership structure: the conceptual and empirical framework • Section 284(1) specifies the duty of a promoter to extend full cooperation to the company liquidator. • Section 300(1) stipulates the promoters’ liability of being examined before the Tribunal upon the report of the company liquidator. Finally, it is important to note that shareholding by promoters both domestic and foreign has an important bearing on the overall operational efficiency, functioning and financial performance of a business corporation. The impact of promoters on corporate profitability and market valuation has been theoretically accepted and empirically endorsed. The promoters being the owners of the business are supposed to be very much concerned, interested and deeply engaged in the management of affairs of a business enterprise. They are also reasonably expected to normalize the type I agency problem, i.e. conflict of interest between the managers and the shareholders as a whole, by actively motoring and controlling management opportunistic or self-servicing behaviour. In this regard, domestic promoters normally play a very significant role in ensuring the effective and efficient functioning of businesses (Pandey and Sahu, 2017b). The empirical studies like Shleifer and Vishny (1986, 1988), Kaur and Gill (2007), Haldar and Rao (2011), Tawiah et al. (2015), Pandey and Sahu (2017a), etc., find a significant linkage between promoters’ ownership and financial performance of firms in the context of different economies. Therefore, based on the theoretical discussion given above, we can sensibly assume a significant and likely positive influence of promoters’ shareholdings on the profitability and marketrelated performance of Indian manufacturing companies. Institutional investors’ ownership

Intuitional investors form an important kind of ownership in the Indian corporate sector in general and in manufacturing firms in particular. On average, near about one-fourth of ownership stake of Indian manufacturing firms is seen to be held by institutional investors (Pandey and Sahu, 2017a). In many countries, institutional investors are gradually becoming dominant players in the capital markets (Gillan and Starks, 2003). The important categories of institutional shareholders are banks, non-banking financial companies (NBFCs), mutual fund companies, insurance companies, etc. These financial institutions generally hold a jury of professionally qualified, chartered and highly experienced investment analysts who undertake a lot of effort in terms of rigorous monitoring and active participation in the management of affairs of their company to ensure a good return on their investments. Therefore, institutional shareholding is another crucial component of companies’ ownership that influences their operational efficiency, performance and valuation. However, it is important to note that the emergence of institutional investors and their activities in the Indian security market has largely increased after the rigorous capital market reforms that took place in the subsequent years of the sweeping economic liberalization of the Indian economy initiated in the year 1991. Let’s look at the important stock market reforms that have rigorously modified and finally made

Ownership structure: the conceptual and empirical framework  43 a paradigm shift in the institutional investment scenario in the Indian corporate sector: • Four committees, namely, Pherwani Committee, Ajit Dey Committee, Dave Committee and Pherwani Committee, were set up by the Government of India (GOI) to critically look into the various issues and problems of the Indian capital market as a whole. • The GOI also welcomed a couple of trustworthy and renowned foreign institutional investors (FIIs) including mutual fund companies, investment trusts and asset management companies, etc., to invest in Indian stock markets. • The government relaxed a couple of norms pertaining to the investment of nonresident Indians (NRIs) in the capital market. • NRIs and foreign corporate bodies were allowed to buy securities subject to prior permission of the Reserve Bank of India (RBI). • The GOI had established the Over-the-Counter Exchange of India (OTCEI) in 1990 under the Companies Act, 1956, with the objective to provide a costeffective platform for sourcing finance for the enterprising promoters for their new projects and a transparent & efficient mode of trading for the investors of the stock market in general. • The GOI permitted mutual funds companies to act as the underwriter to public issues. • Aiming at broadening the government security market, in July 1997, FIIs were allowed to invest in government securities. • Remarkable modernization of stock exchanges was undertaken. Electronic on-line and screen-based trading system was introduced by a number of stock exchanges. All these above reform initiatives have considerably changed the status and involvement of Indian and FIIs in the ownership of Indian corporate firms. Let us now briefly discuss the important constituents of institutional investors in the context of the Indian capital market. The following are the important parties which constitute the institutional investment category in the Indian security market. Banks

Banks are the most common form of financial institutions for any country. Typically, a bank is a financial institution that accepts a large volume of deposits of money in general from the public and lends a major part of the deposits to the individuals and organizations having requirements of credit. The banks undertake a flurry of economic activities like accepting deposits from the public, granting loans and advances, providing overdraft facilities, discounting of bills, issuing letter of credit, undertaking safe custody of valuables like pieces of jewellery made with diamond, gold, etc., providing consumer finance, granting educational loans, etc. Banks are the most important and basic constituent of institutional investors in the Indian and many other markets. Practically speaking, banks deal with

44  Ownership structure: the conceptual and empirical framework public savings and the pool of deposits taken from the public becomes the source of investment by banks. The performance of a bank depends upon how wisely they invest their funds and nurture their investment. If a bank continues to fail in earning an adequate return from its investment then it will no more be capable of maintaining a good customer base and may even lose public faith in case of any default in repayment to the depositors. Therefore, banks as institutional investors of the corporate sector need to be much more sensible, aware and accountable while taking investment decisions and undertaking the further course of nurturing of investments. This is why banks are supposed to be the most cautious and engaged institutional investors of corporate enterprises. Being the most prominent category of institutional investor, banks are supposed to exert a crucial influence on the quality of management and overall functioning of a business concern including its internal governance mechanism, core business practices and financial performance. In a study, Ameer (2010) shows how foreign banks as institutional investors play an important role in improving operational efficiency in the form of better inventory and cash management of the non-financial business corporation in the industrial sector of several Asian economies. Mutual funds

Mutual fund companies or simply mutual funds are the financial institutions that offer small investment opportunities, called ‘units’, to the public and bring together a pool of investable funds or money and finally invest it in shares, bonds or other forms of assets. The combined holding of different kinds of securities and assets is known as a portfolio. Mutual fund companies are becoming attractive avenues of investment for small investors because they provide a whole gamut of services and benefits that an individual investor cannot avail in the normal course of a personal investment process. First of all, they allow investors having a very small size of investable fund to participate in equity investment through the purchase of units of mutual funds. Therefore, investors who are unable to purchase a whole lot of securities can also enjoy the benefits of security market investment through mutual funds. Second, mutual funds allow investors to diversify risk through investment in a bunch of securities with varied risk-return characteristics. Hence, loss from one or more securities is likely to be offset from the gain in other securities. Apart from these, high liquidity, convenience in investment, benefit of professionals’ expertise, economies of scale, etc., are the important advantages of mutual fund investments, which make these institutions an attractive place of investment. Mutual funds are an important constituent of the institutional investors group in India. The mutual fund companies employ experts including security and investment analysts, fund managers, etc., who are supposed to exercise a considerable degree of control and regulation on the management of affairs of the corporation in which they have invested. The stewardship on the part of fund managers acts as a strong governance mechanism for management and results in lessening of the principalagents agency problem in the business corporation. However, fund managers, influenced by some private incentives, can even act in line with the managers of such a

Ownership structure: the conceptual and empirical framework  45 corporation (Bebchuk et al. 2017), which may deteriorate the quality of governance and thereby operational efficiency and performance of companies. Therefore, due to self-opportunism the fund managers of mutual funds can compromise stewardship and provide undue support to the management by taking their side. In this way, mutual funds can play an important role in the governance and performance of companies. Now, the mutual funds are also one of the main constituents of the institutional investor category in the Indian manufacturing sector; therefore, we reasonably assume a considerable effect of those mutual funds on the internal governance, agency cost and performance of the companies under the sector. Insurance companies

Insurance companies are also an important contributor to institutional investment in the corporate sector. They are a kind of financial institution that generally insures people by selling the promise to pay for certain kinds of expenses in return for a regular fee, called a premium. For example, if someone purchases health insurance from an insurance company then it will pay for the client’s entire or a part of the medical bills. Likewise, in life insurance, the company provides the client a certain sum of money in case of his or her death. Insurance businesses, both general and health, are growing in India and many other countries in the world at a rapid pace due to high demands of health and after death family security, non-life or general aspects of security, etc., and this is the reason why these institutions are gradually becoming active participants in the ownership and control of the corporate sector. Like any other financial institutions, insurance companies in India are also taking active participation in the management of affairs of business corporations in which they have invested their funds. They are also supposed to exercise stewardship in the form of imposing necessary restrictions in uneconomic business activities, infusing regulations to curtail agency problems and bestowing serious participation in the decision-making processes of corporate enterprises in India to ensure a better return on their investment. Therefore, insurance companies also form an important part of the institutional investor category and therefore we reasonably suppose a considerable impact of this kind of investor on the performance of Indian manufacturing companies. NBFCs

The non-banking financial institutions are also progressively emerging as an important institutional investor of Indian public limited companies. NBFCs are registered under the Companies Act, 2013, and previously the Companies Act, 1956, of India. This type of financial institution provides loans and advances to the public, holds securities of corporate firms, undertakes hire-purchase insurance business and chitfund business, etc. The functioning of NBFCs is regulated by the RBI. Similar to the earlier discussed constituents of the institutional investor category, NBFCs are also treated as important institutional investors having substantial ownership and thereby control in the Indian corporate sector. In this study, we also assume NBFCs to have considerable bearing on the performance of Indian manufacturing firms.

46  Ownership structure: the conceptual and empirical framework So far, we discussed the concept, significance and the important constituents of the institutional investor category in the Indian manufacturing sector. Now, it is important to understand that from a general perspective institutional ownership is hypothetically associated with the internal governance and performance of firms. In this connection, it can be stated that the theoretical conception and empirical background suggest a favourable as well as an adverse impact of institutional ownership on the overall governance and management of a firm. Consequently, in a similar way, it is supposed to have a positive as well as a negative impact on corporate financial performance. Actually, the kind of impact the institutional shareholders would exert in a corporate enterprise is largely dependent on the kind of role they are pursuing. This is because sometimes it may so happen that the investment managers within the institution get their own agency problems with the investors and they for the sake of private benefits provide undue support to the management. They exercise reasonably weak stewardship to the management out of self-opportunism (Bebchuk et al., 2017). Pound (1988) gives a more comprehensive and holistic view of the association between institutional ownership and firms’ governance and performance. According to him, the effect of institutional ownership on firm governance, performance and valuation is conditioned under three hypotheses: efficient monitoring hypothesis, conflict-of-interest hypothesis and strategic-alignment hypothesis. The efficient monitoring hypothesis views institutional shareholders as investment experts, efficient monitors and active participants towards the business affairs of the companies. According to this hypothesis, the institutional investors are professionally qualified, chartered security analysts who not only have the expertise in making investment decisions but also have the required efficiency and understanding on nurturing investment and ensuring stringent & fruitful internal governance in an enterprise. They act as a watchdog to the management and regulate every significant decision taken and actions undertaken in the business to ensure better financial performance. In this way, they act as a disciplinary mechanism towards the principal-agent agency clash. Therefore, this argument predicts a favourable impact of institutional ownership on companies’ financial performance. On the contrary, the conflict-of-interest hypothesis postulates a negative impact of institutional shareholding on the performance of companies. According to this hypothesis, in view of other business relationships with the company an institutional investor may provide undue support to the management of the company (Brickley et al., 1988). With the objective of maintaining a healthy business relationship, the institutional investors are coerced to vote in favour of management, even compromising the interest of the company as a whole. Again, the strategic-alignment hypothesis views that many a time the institutional investors and the managers of the company find it advantageous to develop a mutual understanding and cooperate with each other, compromising the larger interest of the business. This mutual cooperation nullifies the positive effect of active monitoring and leads to lower firm performance. Thus, both the conflict-ofinterest hypothesis and the strategic-alignment hypothesis predict an unfavourable impact of institutional ownership on the performance of companies.

Ownership structure: the conceptual and empirical framework  47 Therefore, in a nutshell, it can be said that institutional investors as a whole are supposed to exercise considerable stewardship or control on the management of companies which would probably not be possible for the individual investors with a very small fraction of ownership and almost no expertise in corporate governance. Although in our analysis we are going to measure the impact of institutional shareholders as a whole, making a separate discussion on each of the major constituents as done in this chapter is important to have a theoretical and conceptual understanding. Ownership structure and vertical agency problem For a publicly held company especially with a dispersed ownership structure, the challenge for the shareholders is to safeguard their objective from managerial opportunism (Miguel et al., 2004). Under such circumstances, the various forms or constituents of ownership, i.e. the promoters and institutional shareholders, can act as active supervisors of the management and restrain managerial opportunistic behaviour. In SEBI’s Substantial Acquisition of Shares and Takeover Regulations, 1997, and Disclosure and Investment Protection Guidelines, 2000, promoters are supposed to exert significant influence on firm activities by rigorously supervising and disciplining corporate affairs by virtue of their shareholding and cash flow rights. Besides promoters, the institutional investors are supposed to have a fair interest and high expertise in nurturing the investment and other corporate decisions in their invested firm. They also closely guide and monitor the management of affairs of the corporation and considerably discourage managerial self-servicing attitudes. Thus, various forms of equity ownership are supposed to exert significant impact on the owner-managers agency problem, i.e. vertical agency problem of firm. Equity ownership and corporate performance: empirical evidence The ownership-performance nexus has been the topic of intensive academic research in corporate finance literature. The relationship between these two variables is theoretically complex and empirically dubious. The ownership-performance relationship has been widely explored in the context of various developed markets and more recently in the context of a few emerging market economies. However, it has been largely unexplored in India’s recent regulatory and economic framework. Notably, the earlier studies on the equity ownership-firm performance relationship have been mostly conducted in the light of concentration or dispersion of ownership and the role of large and minority owners. The various forms or composition of ownership have gained considerable research interest only in the last two decades. Let us proceed to the important empirical investigations which involve analysis of the statistical association between various forms or composition of ownership and corporate performance. We start with the important studies conducted mainly focusing on the role of institutional investors ownership towards corporate financial performance in the context of different emerging and emerged markets.

48  Ownership structure: the conceptual and empirical framework Institutional ownership and firm performance

To start with, McConnell and Servaes (1990) carry out a famous empirical investigation on the relationship between institutional ownership, insider ownership and financial performance of companies. The study makes an in-depth statistical analysis and confirms a curvilinear relationship between insider ownership and corporate performance. The study also establishes a significantly positive relationship between the fraction of stock owned by institutional investors and performance measured by Tobin’s Q. Finally, the study concludes that corporate value is a function of corporate equity ownership structure. Similarly, Chaganti and Damanpour (1991) try to explain the relationship between outside institutional shareholdings, a firm’s capital structure and performance. For the purpose of the study 40 U.S. manufacturing firms are chosen as a sample for a period of three years. The study shows how the proportion of outside institutional ownership significantly affects the capital structure and corporate performance. A few years later, Craswell et al. (1997) empirically tested the statistical association between insider ownership and institutional shareholders’ ownership in the context of the Australian market. The study constructs a sample consisting of 349 publicly traded Australian companies for the period of 1986–1989. The study establishes a curvilinear relationship between insider or managerial shareholding and corporate performance where the relationship is found to be inconsistent across companies. Besides, regarding institutional shareholding, the study does not evidence any significant contribution of this ownership type on the corporate performance of Australian companies. Later on, Kumar (2004) analyses a set of panel data on Indian corporate firms to establish the ownership-performance nexus. The study observes high crosssectional variations in performance in Indian companies. Regarding the ownershipperformance relationship, the study confirms a non-linear effect of managerial and institutional investors’ shareholding on corporate financial performance. The financial institutions are found to play an active monitoring role when they hold at least 15 percent of a company’s ownership. The study also finds a significant influence of dominant shareholders on the performance of Indian companies. In a subsequent attempt, considering the increasing participation and role of institutional investors in the U.S. capital market, Tsai (2005) in his dissertation work tries to examine the effect of such investors on the financial performance of the companies from the casino, restaurant and hotel sectors for the period of 1999–2003. The study finds that for the companies belonging to the restaurant and casino sector firm performance and percentage of intuitional shareholding are significantly dependent upon each other. However, the study after controlling the firm-specific variables finds no evidence on the statistical relationship between institutional ownership and performance of firms in the hotel sector. The ownership-performance nexus also becomes the research interest of Douma et al. (2006) in the context of the 1,005 Bombay Stock Exchange (BSE) listed companies of India. The study measures firm performance by return on assets (ROA) and Q ratio. The study based on the analysis of data finds that FIIs’ shareholdings in the Indian firms have no such clear-cut impact on the performance measures

Ownership structure: the conceptual and empirical framework  49 used in the study. Based on this finding, the study suggests that those researchers that establish a statistical relationship between foreign institutional ownership and Indian firms’ performance need to do further reviews on the same. The study also endorses the need to treat foreign portfolio or intuitional ownership and foreign direct ownership separately while statistically linking foreign ownership with firm performance. The study also documents a positive impact of block holdings by domestic corporations and financial institutions on firm performance and the monitoring ability of the former is found to be higher than that of the latter kind of ownership. Concurrently, Patibandla (2006) examines the effect of foreign equity ownership on firm performance in the Indian corporate sector. The empirical analysis is based on the firms of 11 Indian industries for the period of 1989–1999. This paper treats foreign investors and government-owned local financial institutions separately as large investors. The empirical results of the study show that foreign investors contribute positively to the corporate performance of Indian corporations. But regarding the ownership of government financial institutions, the effect is found to be negative. The researcher finally suggests reducing the participation of government financial institutions and to encourage foreign investors with an effective regulatory framework to improve corporate governance and performance. Moreover, An et al. (2006) make a sincere attempt towards advancing the extant literature on the relationship between ownership type and corporate performance in the context of 12 publicly traded newspaper companies for the period of 1988– 2000. The study on the basis of its findings confirms that institutional investors’ shareholding, which includes the share ownership by banks, asset management companies and insurance companies in a particular year, is negatively related to the profitability of the subsequent years when profitability is measured by ROA and return on equity (ROE) of the sampled companies. The study finally reaches the conclusion that the concerned institutional investors are not working as activists; rather, they are compromising the overall organizational interest for their other business relationship with the firms. Therefore, the study is in line with Brickley et al. (1988) and Pound (1988) finally endorses the conflict-of-interest hypothesis regarding the relationship between institutional ownership and firm performance. Afterwards, Tsai and Gu (2007) in the context of the U.S. examine the actual statistical association between institutional investors’ ownership and firm performance in the restaurant industry for the period of 1999–2003. The researchers consider the endogeneity issue relating to ownership structure and employ a simultaneous equation framework to gauge the relationship between the two variables. The study approves the favourable role of institutional ownership on the performance of U.S. firms. In a distinct attempt, the famous study by Ghosh (2007) provides important insights into the relationship between institutional ownership and corporate performance in India. The study shows how external monitoring efforts by banks complement internal monitoring by management and an increase in external monitoring leads to a rise in the incentive of managers to monitor the activities of the business efficiently. However, the more specific analysis produces quite different findings and shows that the complementary effect is not found in small-sized companies. Another concurrent study by Farooque et al. (2007)

50  Ownership structure: the conceptual and empirical framework makes an empirical investigation with the objective to produce evidence on the ownership-performance association of companies in the context of Bangladesh. The study constructs an unbalanced pooled sample consisting of 660 firm-years for the period of 1995–2001. The study based on ordinary least squares (OLS) estimation confirms that there is no statistically significant effect of equity ownership structure in forms of government shareholdings, shareholding by the BoD and public shareholding, etc., on the financial performance of Bangladeshi companies measured by ROA and Tobin’s Q. However, the study finds a non-linear U-shaped effect of institutional ownership type on companies’ performance, which implies that institutional investors play an effective monitoring role only after holding a substantial proportion of companies’ ownership. In addition to that, Bhattacharya and Graham (2007) investigate the relationship between institutional ownership and performance of the corporations of Finland. For the purpose of analysis, 116 firms are selected as the sample for the year 2004. Firm performance is measured by Tobin’s Q. Besides, leverage, capital expenditure, market risk and firm size are taken as the control variables. Furthermore, the study considers nine industry-specific dummies, which include industries like information technology, consumer discretionary, the healthcare industry, telecommunications, real estate, etc., to ensure robust results. To establish the actual empirical relationship, three-stage least squares method is employed by the researchers. The study finally finds that proportion of ownership held by institutional investors has a significant and negative effect on firm performance. Later on, Khan (2008) tries to empirically understand the effect of institutional shareholding on the financial performance through effective monitoring and increasing the quality of management in Indian corporations. The findings of the study reveal that the role of institutional investors towards the BoD’ meetings, promoting management practices, increasing productivity & efficiency and ensuring the smooth functioning of the company has been dissatisfactory. Further, the study also finds that the role of institutions like pension funds and mutual funds is not so dynamic in corporate governance. In the context of the European market Baert and Vennet (2009) examine the relationship between shareholding by financial institutions and the performance of firms. As the sample of the study, 2,851 non-financial listed companies from EU15 for the period 1997–2006 are selected. The dependent variable, i.e. firm performance, is measured by Tobin’s Q. Based on the empirical analysis, the study corroborates that there is a negative relationship between shareholding by the financial institution and the market value of firms. The researchers also state that the results of the study disapprove the active monitoring role of institutional investors in nonfinancial listed European companies. Subsequently, Sahut and Gharbi (2010) focus on the French market to establish the interrelationship between institutional ownership and corporate performance measured by Tobin’s Q. The study follows a very strong research method and involves useful econometric tools to arrive at the results. Based on rigorous econometric analysis, the study evidences the presence of institutional shareholders activism in French companies, which ultimately has a favourable impact on

Ownership structure: the conceptual and empirical framework  51 financial performance. The study also states that the relationship between these two variables is bilateral. After a couple of years, Striewe et al. (2013) in their empirical investigation in the context of 155 real estate investment trusts (REITs) from the U.S. for the period of 1998–2010 try to understand how institutional ownership can affect their performance. The study applies Fama-MacBeth firm fixed effect estimation and two-stage least squares fixed effect regression estimation to arrive at the results. Based on the statistical analysis of data, the study confirms a positive relationship between institutional ownership and performance of REITs as measured by ROA. The institutional shareholding is also found to have a favourable impact on the market value of the sampled firms when measured by Tobin’s Q. An increase in institutional ownership is found to affect ROA within five quarters and Tobin’s Q within three quarters. Concurrently, Ting (2013) emphasizes on both the impact of insiders’ and institutional shareholding on corporate financial performance in the context of Taiwan. Based on the findings of the study, the researcher confirms a statistically significant and positive association between both the forms of ownership and the performance of Taiwan firms. Moreover, based on the results, the study concludes that in Taiwan firms the efficient monitoring effect is more powerful than the convergence-ofinterest effect. The empirical inquiry by Boroujeni et al. (2013) in the context of 123 Iranian companies listed and traded on the Tehran Stock Exchange (TSE) for the period of 2001–2008 shows how the forms of ownership can significantly determine the corporate financial performance. The study specifically shows that the proportion of ownership by institutional shareholders contributes significantly and positively towards the performance of the sampled firms measured by ROA. The study based on the results endorses the efficient monitoring effect generated by the institutional investors on the operations and management of the Iranian companies. A few years later, Asadi and Pahlevan (2016) make a statistical examination of the relationship between ownership structure and firm performance in the context of 102 companies listed on the TSE for five years from 2007 to 2011. The study applies multiple mean comparison tests and analysis of variance, i.e. ANOVA, to arrive at the results. Based on statistical and econometric analysis, the study confirms that the various commonly used performance measures like ROA, ROE, MBVR and market value added (MVA) are the functions of equity ownership. More specifically, the study shows that public ownership and institutional investors’ ownership positively influence all the above-mentioned measures of corporate performance. Ting et al. (2016) in the context of the Malaysian market show how the performance of 201 listed companies for the period of 2002–2011 significantly affected the type of ownership. The study especially shows a statistically significant and positive relationship between foreign ownership (foreign investors, foreign institutions) and the performance of the sampled companies. Besides, the study interestingly documents the moderating effect of research and development (R&D) activities on the ownership-performance nexus.

52  Ownership structure: the conceptual and empirical framework With the objective to find out the ownership-performance relationship in the context of Indonesia, the study of Saleh et al. (2017) uses a sample of 40 property and real estate firms during the period 2010–2015. The study employs the fixed effect model (FEM) and the random effect model (REM) model under panel data estimation to arrive at the results. Based on the panel data regression results, the study approves the role of institutional investors on the performance of Indonesian property and real estate firms for the considered period. Furthermore, El-Habashy (2019) studies the effect of the composition and concentration of ownership and firm performance in the context of 40 most active Egyptian non-financial companies for the period of 2009–2014. The study uses ROA, ROE and Tobin’s Q to measure firm performance. Based on data analysis, the study documents a significantly positive relationship between the proportion of institutional ownership and the financial performance of the sampled firms. However, equity ownership by managers and ownership concentration is found to be insignificant compared to the accounting and market-based performance of the firms. The study of Daryaei and Fattahi (2020) makes an attempt to examine the efficient monitoring and convergence-of-interests hypotheses relating to institutional ownership in the context of 177 firms listed in the TSE from 2009 to 2018. The study using panel smooth transition regression model reports that when the levels of institutional ownership remain below 28.5% and 43.5% (for ROA and Tobin’s Q respectively) the performance increases with increasing institutional ownership. However, in the second regime, the trend is found to be reversed when the levels of institutional ownership remain above 28.5 percent and 43.5 percent for ROA and Tobin’s Q respectively. In a quite recent development, Rashid (2020) in the context of Bangladesh reports no such significant effect of institutional shareholding on the value or market-based performance of companies. However, it is found to be positively related with accounting performance. Promoters’ ownership and firm performance

Extensive empirical investigations have been conducted that specifically focused on the role of promoters towards the operational efficiency and financial performance of companies. To start with, the empirical investigation by Chakrabarti (2005) focuses on the Indian corporate sector to conduct a study on various aspects of corporate governance and highlights the presence of pyramiding and tunnelling effect of promoters’ stock ownership in Indian companies. Later on, Rao and Guha (2006) focus on the ownership pattern of Indian companies, especially of the family-controlled firms. For the purpose of the study, the researcher makes a review of the ownership patterns of Indian companies which are primarily familycontrolled or group affiliates for the period 2002–2003 to 2003–2004. The pattern of ownership of such companies is shown by using various charts and tables. They observe that a substantial portion of shareholdings of Indian companies is owned by promoters and their affiliates. They also find that, on average, a quarter of the ownership stake is owned by institutional investors who are believed to be the better monitor of corporate affairs. Individual small shareholders are found to be

Ownership structure: the conceptual and empirical framework  53 relatively marginal in terms of control and ownership percentage and do not have considerable participation in corporate decision-making. Notably, Haldar and Rao (2011) analyse the interrelationship between ownership structure and performance of firms in the context of the Indian market. The study considers companies listed on the BSE 500 index of India for the period of 2001–2008. The study applies panel data regression analysis and more specifically fixed effect and random effect estimation to arrive at the results. Based on the data analysis, the study finds that ownership by promoters in those companies has a positive impact on the financial performance measured by ROA, return on capital employed (ROCE) and Tobin’s Q. The study clearly infers that non-promoter ownership doesn’t significantly contribute to the performance of Indian companies. Besides, according to the results of the study, some unobserved firm characteristics can explain a large fraction of Indian companies’ financial performance. Moreover, Nakanoa and Nguyen (2013) examine the effect of foreign ownership on the performance of the electronics industry in Japan. The study measures financial performance by using two variables, i.e. ROA and Tobin’s Q. The study documents a positive impact of foreign investors’ ownership on the financial performance of Japanese electronics companies. Concurrently, the empirical investigation by Gugnani (2013) tries to explore the statistical association between a number of corporate governance parameters like board composition, the board size, promoters’ holding, etc., and firm performance. Considering the listed Indian manufacturing companies for the period of 2005–2012 and employing the OLS method, the study confirms that corporate performance is positively related to promoters’ shareholding. At a subsequent stage, Tawiah et al. (2015) aim at establishing the relationship between promoters’ shareholding and corporate value. The researchers take a total of 125 observations from 25 listed Indian firms out of Nifty 50 companies for the period of 2009–2013. Interestingly, the study documents an inverse relationship between the proportion of share ownership by promoters’ and shareholders’ wealth. Again, Bansal and Singh (2015) undertake research efforts to empirically establish the ownership-performance nexus in the context of India. The study uses a sample consisting of 137 publically listed companies that belong to the FMCG sector of the Indian economy. The study measures corporate performance by ROA and employs paired sample T-test and ANCOVA to arrive at the results. Based on the analysis of the concerned data, the study finds a significantly positive impact of promoters’ ownership on corporate performance in the Indian FMCG sector. The researchers further state that the results relating to the relationship between promoters’ shareholding and corporate performance signify the alignment of interest hypothesis. Nazir and Malhotra (2016) using panel data of BSE 100 index companies try to empirically establish the ownership-performance relationship. The findings of the empirical investigation by the researchers confirm that the non-promoter ownership and non-promoter non-institutional shareholding have no significant impact on the performance measured by earnings per share (EPS). Moreover, promoters’ ownership, non-promoter ownership and non-promoter non-institutional shareholding are

54  Ownership structure: the conceptual and empirical framework found to be significantly related to the performance measure return on investment (ROI). The ownership by the promoter and non-promoter institutions is found to be irrelevant to profit after tax (PAT). Besides, the study also confirms the existence of concentrated ownership in Indian companies. The study of Pandey and Sahu (2017a) in the context of the Indian manufacturing sector applies panel data regression estimation to test the impact of various forms of ownership including domestic promoters’ ownership, foreign promoters’ ownership and institutional shareholding on the corporate performance measured by ROA and return on net worth. The study based on the results of the FEM confirms that domestic promoters’ shareholding has a significant and positive impact on both the measures of firm performance. The ownership by foreign promoters is also found to affect one of the performance variables, i.e. ROA of Indian manufacturing firms. The institutional shareholding is also found to have a favourable impact on firm performance. Based on the study findings, the researchers infer that the effect of active monitoring on the part of promoters and institutional investors is present in the Indian manufacturing sector, which leads to the generation of an incentive effect on their operational efficiency and performance. Similarly, aiming at establishing the relationship between equity ownership structure and firm value, Mishra and Kapil (2017) construct a sample of 391 Indian companies from the CRISIL NSE index (CNX) 500 companies listed and traded on the National Stock Exchange (NSE). The study points out a statistically significant and positive relationship between promoter shareholding and Tobin’s Q. The study also infers that the proportion of promoters’ ownership affects the performance of the sample companies differently at varying levels of ownership by promoters. The effect of domestic promoters’ shareholding on the performance of firms was studied by Pandey and Sahu (2017b). The study uses ROA and ROCE to measures corporate financial performance. Based on the results obtained from panel data regression analysis, the study establishes a highly significant and positive effect of domestic promoters’ ownership on all the proxies used in the study. The researchers conclude that the findings of the study go in line with the supposition of active monitoring and supervisory role of promoters. Other forms of equity ownership and financial performance

In this subsection we discuss the literature that studies the statistical relationship between a few other important forms of equity ownership and corporate performance. To start with, Lauterbach and Vaninsky (1999) perform an empirical analysis on 280 Israeli companies listed in the Tel-Aviv Stock Exchange for the year 1994. The study employs Data Envelopment Analysis for the purpose of analysing the concerned data. Results of the study suggest that when the firms are controlled and run by an owner-manager they underperform in generating net income and on the other hand when firms are managed by a professional (non-owner) manager they perform well in this regard. Besides, Welch (2003) examines the relationship between ownership type and firm performance in the context of listed companies in Australia. The study based

Ownership structure: the conceptual and empirical framework  55 on the result of the OLS model suggests that equity ownership has crucial relevance towards the performance of the sampled firms. The study also tests the non-linear effect of managerial ownership on performance and finds no such strong evidence on the non-linearity in the relationship of the two variables. Notably, Pant and Pattanayak (2007) focus on 1,833 companies that are listed and traded on the BSE for the period of 2000–2004. The study confirms that the relationship between the proportion of insider ownership and firm value measured by Tobin’s Q is non-monotonic. More specifically, the study suggests a cubic relationship between the variables. Again, Alam (2008) investigates the impact of ownership patterns on the financial performance of hospitals in the context of the State of Washington over the period 1980–2003. This study evaluates three groups of hospitals that are classified by the ownership structure and these are government, for-profit and not-for-profit companies. The sample consists of 125 hospitals in the State of Washington out of which 51 are government, 61 are not-for-profit and 13 are for-profit hospitals. The results of the study show that the equity ownership structure is statistically associated with corporate performance and there are significant differences in the financial performance among the three groups of hospitals. The results show that not-for-profit hospitals are performing better than both the government and for-profit hospitals even after controlling for other important financial and nonfinancial factors. The empirical investigation of Lafuente et al. (2010) in the context of 163 Spanish manufacturing companies for the period 1996–2000 attempts to interlink ownership concentration with firm performance measured by ROA and ROE. The study infers that the composition of ownership is more important than the concentration of ownership for better monitoring and improving firm performance. It is also found that when the shares are held by multi-national corporations the effect on performance becomes more favourable. Later on, Park and Jang (2010) make an attempt to extend the literature on the linkage between shareholding by insiders and corporate performance in the context of the restaurant industry. The study analyses the data of 251 restaurants using cross-sectional and 2SLS-GMM estimation and establishes a quadratic relationship between the concerned variables. To be more specific, both the entrenchment and convergence-of-interest effects are found to co-exist in such sample firms. The performance measured by Tobin’s Q is found to increase until the insider ownership touches 40 percent and after this threshold, the performance decreases. At a subsequent stage, Ruan et al. (2011), using a sample of 197 China’s civilian-run firms listed on the Shanghai and the Shenzhen Stock Exchange between 2002 and 2007, try to explore the impact of managerial stock ownership on corporate financial performance through capital structure choices. The independent variable, managerial shareholding, is measured by taking the proportion of stake of all board members and the leverage ratio is measured by total debt to total assets (TDTA) ratio. The firm performance is measured through Tobin’s Q. The findings of the study confirm a non-linear association between firm value and managerial ownership. Besides, it is also evidenced that, within the managerial ownership

56  Ownership structure: the conceptual and empirical framework range 18 to 46 percent, the leverage ratio increases along with the enhancement of managerial ownership. Chen et al. (2012) examine the nexus between managerial shareholding and corporate performance in the context of listed tourist hotels of Taiwan. Seven tourist hotels listed on the Taiwan Stock Exchange are taken as the sample. Quarterly data of these sampled hotel companies are collected for 52 quarters from 1997 to 2009. Findings of the study state that insider managerial ownership significantly impacts corporate financial performance when it is measured through ROA, ROE and Tobin’s Q. Further, compared to managers’ shareholding, directors’ shareholding has a more significant impact on the performance of hotels in Taiwan. They also find an inverted U-shape relationship between insider managerial shareholding, directors’ shareholding and hotel performance, which indicates that both the variables initially boost up financial performance up to an optimal threshold point and therefore the results support the convergence-of-interests hypothesis. Concurrently, Wellalage and Locke (2012) study the impact of ownership type on the performance of firms in the context of Sri Lanka. The study uses 152 Colombo Stock Exchange-listed non-financial companies for the period of 2004–2009. The study introduces ROA and Tobin’s Q as proxies of accounting and market-based performance respectively. The study finally documents an inverse U-shaped relationship between insider shareholding and the performance of firms in Sri Lanka. The study based on its findings infers that for Sri Lankan firms lower insider shareholding results in the misalignment of interest between managers and owners whereas higher insider shareholding promotes managerial entrenchment effect, which leads to lower firm performance. Subsequently, Karpagam et al. (2013) explore the role of Indian promoters’ and foreign promoters’ and other forms of ownership on firm performance. The study considers BSE listed companies for the period of 2007–2011 to establish the relationship. The results of OLS estimation suggest an insignificant relationship between ownership structure variables and corporate performance. Again, Colombo et al. (2014) explore the relationship between ownership structure and high-tech entrepreneurial firms’ performance in the context of Italy. For the purpose of empirical investigation, the article considers 255 Italian unlisted high-tech entrepreneurial firms for the period of 1994–2003. The number of owner-cummanagers and the number of non-manager individual shareholders of the firm are considered as independent variables. The study uses the proxy total factor productivity (TFP) growth to measure corporate performance. The researchers assess the effect of ownership structure on TFP growth through the system-GMM estimator for panel data. The study finds that firms with a greater number of owner-managers exhibit better performance. The researchers also conclude that individual shareholders do not significantly influence corporate financial performance. Moreover, Michel et al. (2014) make an attempt to find out the relationship between the percentage of public float and post-IPO returns, considering a sample of 1,801 IPOs. They find a quadratic (U-shaped) relationship between these two variables. This U-shaped relationship is explained by the trade-off between the incentive of insiders or actual owner and their controlling power or ownership.

Ownership structure: the conceptual and empirical framework  57 The U-shaped relationship reveals that when the public float through IPO increases, the incentives to the insiders decrease due to comparatively smaller post-IPO ownership, which leads to lower post-IPO returns. At the same time, higher public float leads to an increase in the ownership of the public, which makes them stronger in governing or monitoring the performance of the firm. Finally, the researchers reach the conclusion that the firm performs best either when it floats very little to the public through IPOs or when it sells most of its stock in the IPOs. In the recent past, Zraiq and Fadzil (2018) inquire about the ownership-performance relationship in the context of Jordan. Applying the OLS regression model the researchers find that forms of ownership have crucial relevance towards corporate performance. The study specifically establishes a statistically positive impact of foreign ownership and family ownership on the performance of Jordanian companies. Related studies

So far, we have discussed the empirical studies focused on the relationship between different form of equity ownership and financial performance of firms. However, there is another gamut of empirics that tried to interlink corporate ownership with a set of other dependent variables close to financial performance. For instance, a recent empirical investigation by Arora and Singh (2020) reports a curvilinear relationship between promoters’ shareholdings and the under-pricing of small and medium enterprise (SME) IPOs in India. Corporate ownership is also empirically linked with other variables like attaining competitive advantage (Nkundabanyanga et al. 2018), adoption of International Financial Reporting Standards (Bananuka et al., 2019), choice of dividend policy (Short et al., 2002, Rajput and Jhunjhunwala, 2019), the likelihood of financial distress (Udin et al., 2017), etc. Interestingly, a number of recent research studies (Shleifer and Vishny, 1994; Boycko et al., 1996; Qian, 1996, Wong et al., 2004) in the context of several markets have highlighted the moderating role of government ownership, political control or any form of policy intervention towards the ownership-performance relationship. The studies have supplied enough evidence on the fact that sometimes political or state intervention can play a significant role in shaping the relationship between equity ownership and the performance of companies. Again, sometimes government ownership mostly through investment companies is found to have a direct effect on the financial performance of companies. For instance, a study by Taufil-Mohd et al. (2013) in the context of 190 Malaysian companies listed on the Main Market of Bursa Malaysia over a ten-year period from the years 2000 to 2009 finds crucial evidence on the favourable effect of government-linked investment companies’ ownership on firm performance. The study has highlighted the role of such ownership towards better monitoring of the management of affairs of the companies, which leads to improved financial results. Where in many cases policy intervention is found to bring favourable results, it is also argued that many times politicians and bureaucrats attempt to use state ownership as a powerful instrument to serve their political objectives (Jones, 1985),

58  Ownership structure: the conceptual and empirical framework which deviates from the profit-maximizing objective of firms, leading to underperformance (Shleifer and Vishny, 1994; Boycko et al., 1996). Concluding remarks As in the case of the capital structure-performance relationship, the research efforts directed towards empirically establishing ownership-performance relationship also lead us to heterogeneous findings. After reviewing the existing literature on this topic, it is well understood that the statistical relationship between these two variables is subject to the moderation of many firm-specific and external factors like size of the firm, economic perspective, the time frame of the study, country origin of the equity holders, policy intervention, etc. Thus, there is always room for producing fresh empirical evidence in the context of a specific country. References Alam, P. (2008). The effect of ownership structure on performance of hospitals. Academy of Accounting and Financial Studies Journal, 12(3), 37–51. Ameer, R. (2010). The role of institutional investors in the inventory and cash management practices of firms in Asia. Journal of Multinational Financial Management, 20(2–3), 126–143. An, S., Jin, H. S., & Simon, T. (2006). Ownership structure of publicly traded newspaper companies and their financial performance. Journal of Media Economics, 19(2), 119–136. Arora, N., & Singh, B. (2020). Corporate governance and underpricing of small and medium enterprises IPOs in India. Corporate Governance: The International Journal of Business in Society, 20(3), 503–525. Asadi, A., & Pahlevan, M. (2016). The relationship between ownership structure and firms’ performance in Tehran stock exchange. Journal of Insurance and Financial Management, 1(2), 62–76. Baert, L., & Vennet, R. V. (2009). Bank ownership, firm value and firm capital structure in Europe. FINESS Working Paper No. D. 2.2. Available at: http://hdl.handle.net/10419/ 119485. Bananuka, J., Kadaali, A. W., Mukyala, V., Muramuzi, B., & Namusobya, Z. (2019). Audit committee effectiveness, isomorphic forces, managerial attitude and adoption of international financial reporting standards. Journal of Accounting in Emerging Economies, 9(4), 502–526. Bansal, S., & Singh, R. (2015). An empirical investigation of influence of ownership structure on firm performance of Indian listed companies. International Journal of Commerce, Business and Management, 4(4), 1268–1277. Bebchuk, L. A., Cohen, A., & Hirst, S. (2017). The agency problems of institutional investors. Journal of Economic Perspectives, 31(3), 89–102. Bhattacharya, P., & Graham, M. (2007). Institutional ownership and firm performance: evidence from Finland. Australasian Meeting of the Econometric Society, 1–33, University of Queensland. Available at: http://dro.deakin.edu.au/view/DU:30007976. Boroujeni, H. N., Noroozi, M., Nadem, M., & Chadegani, A. A. (2013). The impact of capital structure and ownership structure on firm performance: a case study of Iranian companies. Research Journal of Applied Sciences, Engineering & Technology, 6(22), 4265–4270.

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60  Ownership structure: the conceptual and empirical framework Lafuente, E., Bayo-Moriones, A., & Garcia-Cestona, M. (2010). ISO-9000 certification and ownership structure: effects upon firm performance. British Journal of Management, 21(3), 649–665. Lauterbach, B., & Vaninsky, A. (1999). Ownership structure and firm performance: evidence from Israel. Journal of Management and Governance, 3(2), 189–201. McConnell, J. J., & Servaes, H. (1990). Additional evidence on equity ownership and corporate value. Journal of Financial Economics, 27(2), 595–612. Michel, A., Oded, J., & Shaked, I. (2014). Ownership Structure and performance: evidence from the public float in IPOs. Journal of Banking & Finance, 40, 4–61. Miguel, A.D., Pindado, J., & Torre, C. D. L. (2004). Ownership structure and firm value: new evidence from Spain. Strategic Management Journal, 25, 1199–2107. Mishra, R., & Kapil, S. (2017). Effect of ownership structure and board structure on firm value: evidence from India. Corporate Governance: The International Journal of Business in Society, 17(4), 700–726. Nakano, M., & Nguyen, P. (2013). Foreign ownership and firm performance: evidence from Japan’s electronics industry. Applied Financial Economics, 23(1), 41–50. Nazir, N., & Malhotra, A. K. (2016). The effect of ownership structure on firm profitability in India: a panel data approach. International Journal of Economics and Finance, 8(6), 237–249. Pandey, K. D., & Sahu, T. N. (2017a). An empirical analysis on capital structure, ownership structure and firm performance: evidence from India. Indian Journal of Commerce and Management Studies, 8(2), 63–72. Pandey, K. D., & Sahu, T. N. (2017b). An Inquiry into the Impact of domestic promoters’ ownership on performance of Indian manufacturing companies. International Journal of Research in Finance and Marketing, 7(3), 14–24. Pant, M., & Pattanayak, M. (2007). Insider ownership and firm value: evidence from Indian corporate sector. Economic and Political Weekly, 42(16), 1459–1467. Park, K., & Jang, S. S. (2010). Insider ownership and firm performance: an examination of restaurant firms. International Journal of Hospitality Management, 29(3), 448–458. Patibandla, M. (2006). Equity pattern, corporate governance and performance: a study of India’s corporate sector. Working Paper No: 9–2001, Copenhagen Business School. Pound, J. (1988). Proxy contests and the efficiency of shareholder oversight. Journal of Financial Economics, 20, 237–265. Qian, Y. (1996). Enterprise reform in China: agency problems and political control. Economics of Transition, 4(2), 427–447. Rajput, M., & Jhunjhunwala, S. (2019). Corporate governance and payout policy: evidence from India. Corporate Governance: The International Journal of Business in Society, 19(5), 1117–1132. Rao, K. C., & Guha, A. (2006). Ownership pattern of the Indian corporate sector: implications for corporate governance. Working Paper No: 2006/09. Institute for Studies in Industrial Development. Rashid, M. M. (2020). Ownership structure and firm performance: the mediating role of board characteristics. Corporate Governance: The International Journal of Business in Society, 20(4), 719–737. Ruan, W., Tian, G., & Ma, S. (2011). Managerial ownership, capital structure and firm value: evidence from China’s civilian-run firms. Australasian Accounting, Business and Finance Journal, 5(3), 73–92. Sahut, J. M., & Gharbi, H. O. (2010). Institutional investors’ typology and firm performance: the case of French firms. International Journal of Business, 15(1), 33–49.

Ownership structure: the conceptual and empirical framework  61 Saleh, M., Zahirdin, G., & Octaviani, E. (2017). Ownership structure and corporate performance: evidence from property and real estate public companies in Indonesia. Investment Management & Financial Innovations, 14(2), 252–263. Shleifer, A., & Vishny, R. W. (1986). Large shareholders and corporate control. Journal of Political Economy, 94(3), 461–488. Shleifer, A. & Vishny, R. W. (1988). Value maximization and the acquisition process. Journal of Economic Perspectives, 2(1), 7–20. Shleifer, A., & Vishny, R. W. (1994). Politicians and firms. The Quarterly Journal of ­Economics, 109(4), 995–1025. Short, H., Zhang, H., & Keasey, K. (2002). The link between dividend policy and institutional ownership. Journal of Corporate Finance, 8(2), 105–122. Striewe, N., Rottke, N., & Zietz, J. (2013). The impact of institutional ownership on REIT performance. Journal of Real Estate Portfolio Management, 19(1), 17–30. Taufil-Mohd, K. N., Md Rus, R., & Musallam, S. R. (2013). The effect of ownership structure on firm performance in Malaysia. International Journal of Finance and Accounting, 2(2), 75–81 Tawiah, V. K., Benjamin, M., & Banns, J. E. (2015). Nexus between ownership structures and shareholders’ wealth. International Journal of Multidisciplinary Research and Development, 2(4), 226–231. Ting, H. I. (2013). The influence of insiders and institutional investors on firm performance. Review of Pacific Basin Financial Markets and Policies, 16(4), 1350027. Ting, I. W. K., Kweh, Q. L., Lean, H. H., & Ng, J. H. (2016). Ownership structure and firm performance: the role of R&D. Institutions and Economies, 8(4), 1–21. Tsai, H., & Gu, Z. (2007). Institutional ownership and firm performance: empirical evidence from US-based publicly traded restaurant firms. Journal of Hospitality & Tourism Research, ­ 31(1), 19–38. Tsai, M. C. (2005). The impact of institutional ownership on firm performance in the hospitality industry. Doctoral Dissertation, University of Nevada, Las Vegas. Udin, S., Khan, M. A., & Javid, A. Y. (2017). The effects of ownership structure on likelihood of financial distress: an empirical evidence. Corporate Governance: The International Journal of Business in Society, 17(4), 589–612. Welch, E. (2003). The relationship between ownership structure and performance in listed Australian companies. Australian Journal of Management, 28(3), 287–305. Wellalage, N. H., & Locke, S. (2012). Ownership structure and firm financial performance: evidence from panel data in Sri Lanka. Journal of Business Systems, Governance & ­Ethics, 7(1), 52–65. Wong, S. M., Opper, S., & Hu, R. (2004). Shareholding structure, depoliticization and firm performance. Economics of Transition, 12(1), 29–66. Zraiq, M. A. A., & Fadzil, F. H. B. (2018). The impact of ownership structure on firm performance: evidence from Jordan. International Journal of Accounting, Finance and Risk Management, 3(1), 1–4.

4

Ownership concentration and agency problem

Ownership concentration: meaning and significance Ownership concentration refers to the kind of ownership where a substantial part of the total shareholding of a corporation is held by a very limited number of shareholders. Based on the degree of concentration, ownership structure can take two forms: dispersed shareholding and concentrated shareholding. In the case of dispersed shareholding structure, the ownership is distributed among a large volume of owners whereas in a concentrated shareholding pattern a substantial portion of the controlling stake goes to a few large shareholders. However, conceptually when a shareholder can be treated as large is a crucial question because the concept of large shareholder varies across markets. Different researchers (Porta et al. 1999; Selarka, 2005; Brendea, 2014; Vintila et al. 2014) considered a shareholder as large with different criteria based on the percentage of shareholding. However, in most of the cases it is observed that a shareholder is supposed to be large when the ownership stake touches or goes beyond 5 percent. Now, for jointly held Indian corporations, ownership concentration is not a new phenomenon; rather, it has remained an endemic feature since the days of British managing agencies (Balasubramanian, 2010). Not only Indian firms but most Asian firms are either family-controlled or state-controlled, which makes their ownership traditionally concentrated since their establishments (Shakir, 2008). The scene is still prevalent; in fact, ownership concentration in the present days especially in the hands of a few large promoters has become a norm rather than an exception in the Indian corporate scene (Pandey and Sahu, 2019). Notably, while ownership concentration is noticeable in almost all the sectors indiscriminately in other emerging Asian economies, for India the concentration of ownership is much more prominent only in the manufacturing sector (Selarka, 2005). Let us come into the discussion on the significance of such majority shareholders on the governance, agency problem and performance of Indian manufacturing firms. Conceptually, these large/dominant shareholders can exert two types of influences on the corporate governance of Indian manufacturing firms. First, they may safeguard the interest of the shareholders fraternity as a whole by promoting

DOI: 10.4324/9781003397878-4

Ownership concentration and agency problem  63 the wealth maximization objective through better monitoring management and limiting their opportunistic behaviour as proposed by the efficient monitoring hypothesis (Shleifer and Vishny, 1986; Friend and Lang, 1988). As per the proposition of this hypothesis, owners with a substantial proportion of shareholding can be more capable of monitoring and controlling the management of affairs of a company and preventing the opportunistic behaviour of management by virtue of their strong voting rights which ultimately results in decreased owner-managers or vertical agency problem. Conversely, these large owners can expropriate the minority shareholders and unjustifiably extract more benefits at their cost. The expropriation can take place in various ways such as diverting firm resources or assets through self-dealing transactions (Johnson et al., 2000), tunnelling one firm’s resources and profits to another firm to enjoy more cash flow rights especially in a situation when a dominant owner has a controlling stake in two different firms with varied rights on cash flows (Bertrand et al., 2002), subversive behaviour with minority owner and preventing them from exercising their de jure ownership rights (Goswami, 2002) etc. According to the World Bank (1999), a closely held firm with few circumscribed controlling owners faces a situation of undue dominance over and expropriation of minority shareholders by such controlling shareholders. It brings in a challenge for the minority shareholders to prevent and control such extracting behaviour of the large shareholders. Some empirical studies endorse expropriation hypothesis and provide evidence of exploiting or expropriating behaviour of large shareholders and their action against the value maximization objective of a firm as a whole, which leads to the generation of a horizontal or type II agency problem (Fama and Jensen, 1983; Shleifer and Vishny, 1997; Burkart and Panunzi, 2006). Notably, the nature of agency problem in India is seen to be quite different from that of other economies like the U.S. and the U.K. in the sense that where the corporations of these developed countries are facing both kinds of agency issues, i.e. conflict of interest between managers and shareholders (type I or vertical agency problem) and that between minority and dominant shareholders (type II or horizontal agency problem), the latter issue is much more prevalent in the Indian corporate sector (Morck and Yeung, 2003; Roe, 2004). However, the quality of corporate governance in Indian corporations is mainly assessed by its ability to discipline two types of self-servicing attitudes, one is of majority owners and another is of managers (Varma, 1997). It will be very interesting to verify whether the concentrated ownership structure is reducing vertical agency conflict and costs in Indian publicly held manufacturing corporations or it becomes a cause of horizontal agency problem and lowers firm performance. A positive impact on performance with evidence of curtailment in vertical agency cost will definitely endorse their overall internal governance quality. However, the opposite results will indicate the presence of an expropriation effect and their inability to serve as an internal governance mechanism.

64  Ownership concentration and agency problem Ownership concentration and corporate performance: empirical evidence Research on ownership-performance nexus in publicly held corporations dates back to the study of Berle and Means (1932). According to them, business corporations in the U.S. that are operating with a dispersed ownership structure with more concentrated ownership in the hands of insiders or managers tend to underperform. Following this, Jensen and Meckling (1976) developed the agency theory showing that managerial ownership can minimize the agency cost by limiting managerial incentives and can help in aligning the interests of managers & shareholders. However, in contrast to the agency hypothesis, nearly after a decade the eminent empirical study carried out by Demsetz and Lehn (1985) in the context of 511 U.S. corporations documents no such significant relationship between ownership concentration and corporate financial performance. Furthermore, Shleifer and Vishny (1986, 1988) carry out two eminent researches on ownership structure and firm performance including the agency issue. According to their studies, the presence of a large shareholder or group, having dominance over the management, exerts a significant impact on the management of affairs of a corporation by virtue of high controlling ability. It further leads to minimization in agency cost and therefore improved firm performance. In line with these evidences, the eminent empirical research carried out by Wruck (1989) also suggests that block holdings or increased concentration of equity ownership positively affect corporate performance. Further, the researcher shows that the relationship is non-monotonic on abnormal market returns. However, in another study, Leech and Leahy (1991) examine the ownershipperformance relationship in the context of large British companies. The study first identifies that the concentration of ownership in companies is significantly dependent on diversifiable risk, size of firm and product diversification. In contrast to the previous evidence, the study suggests that higher dispersion of ownership leads to higher market value, profit margin and growth of companies. Later on, Mudambi and Nicosia (1998) conduct their research work among the U.K. financial industry with two major objectives. First, they try to assess the impact of concentrated ownership structure and the degree of control on company performance. Second, they review the impact of managerial ownership on firm performance keeping the convergenceof-interest and entrenchment hypotheses into consideration. Data of a sample of 111 companies including banks, insurance and merchant banks, etc., in the U.K. over the period of 1992–1994, are used for the empirical analysis. Regression results show that ownership concentration measured by the Herfindahl index is negatively related to firm performance. The study finally suggests that ownership concentration is not necessarily related to degree of control. The regression results also confirm that managerial ownership has a non-monotonic relationship with performance. Subsequently, Thomsen and Pedersen (2000) examine the impact of ownership structure on shareholders’ value and profitability among the largest European companies. The researchers survey the ownership structures of 435 non-financial companies belonging to 12 European nations in the year 1990. The study finds

Ownership concentration and agency problem  65 that ownership concentration in the form of largest ownership, up to a certain point, can positively contribute towards shareholders’ value measured by market to book value ratio (MBVR) and profitability measured by return on assets (ROA). However, after the threshold point, which is identified as 83 percent, the effect gradually turns negative. Besides, an important finding of the study is that, when the largest owner is an institution, the effect on shareholders’ value is very strong. Therefore, the study covers two important aspects of the ownership-performance nexus; first, it establishes the role of the large owner and, second, it shows the relevance of ownership identity. Just after a year, Demsetz and Villalonga (2001) carry out eminent research on the effect of ownership structure on the performance of 223 companies from the U.S. The study based on its findings infers that the ownership structure of such companies is not significantly related to their performance. The study concludes that while diffused ownership pattern brings about agency problem, it also simultaneously yields some compensating advantages, which ultimately offsets such crisis. Again, Gedajlovic and Shapiro (2002) try to gauge the actual statistical association ownership concentration on the financial performance of companies. The researchers choose a set of 334 Japanese companies for the period of 1986–1991. The study finally suggests a positive relationship between ownership concentration and performance of such sampled firms. Based on the study results, the researcher endorses the agency theory on ownership structure proposed by Jensen and Meckling (1976). Furthermore, Miguel et al. (2004) establish the statistical relationship between concentrated ownership structure and value of firm. The study uses an unbalanced panel data of 135 Spanish companies for the period of 1990–1999. The researchers measure ownership concentration by considering the total shareholding of significant shareholders. The study uses two variables, i.e. ownership concentration and the square of ownership concentration, to determine the two-fold effect of concentrated ownership structure on firm value measured by Tobin’s Q. The study based on dynamic panel data analysis under the GMM (generalized methods of moments) framework establishes a non-linear (bell-shaped) relationship between ownership concentration and the value of Spanish companies. The study specifies that up to a threshold of 83 percent of ownership by significant shareholders the monitoring effect is operational but after this threshold point the expropriation effect becomes more intense, leading to lower firm value. Considering the fact that ownership structures vary considerably across Europe, Kirchmaier and Grant (2005) examine the impact of forms of ownership on firm performance by considering five major European economies, namely, Germany, France, U.K., Spain and Italy. The ownership structures of the sampled firms are categorized into widely held firms, de facto control firms and legal control firms. The study finally documents that dominant shareholders destroy firm value. In a concurrent attempt, Selarka (2005) provides some important empirical insights on the ownership concentration-firm value relationship in the India corporate sector. The study finds that ownership concentration by minority shareholders does not significantly contribute to firm value and therefore their monitoring effect is not operational in Indian corporate firms. Besides, the largest two

66  Ownership concentration and agency problem minority shareholders are found to increase the firm value at a lower proportion of ownership and vice versa. At the same time, Earle et al. (2005) explore the concentration-performance relationship of firms listed and traded on the Budapest Stock Exchange. The study employing fixed effect estimation under panel data analysis documents that the largest shareholders have a very strong influence towards increasing the profitability and operational efficiency of the sampled firms. However, the impact of total block holdings on firm performance is not found to be statistically significant. However, when the individual effect of the largest block holder is controlled, the marginal effect of additional blocks is found to be negative. Finally, the researchers conclude that the marginal cost of concentration outweighs the benefits due to the involvement of multiple players. Later on, Kapopoulos and Lazaretou (2007) examine the statistical relationship between ownership pattern and financial performance in the context of Greece. The study uses a sample of 175 Greek listed companies. The study based on ordinary least squares (OLS) and 2OLS estimations confirms that as the ownership of Greek firms becomes concentrated the performance measured by Tobin’s Q improves. A similar effect on performance is evidenced for managerial ownership type in such firms. Similarly, Perrini et al. (2008) study the impact of forms of ownership like concentrated ownership and managerial shareholding in the context of 297 Italian companies for the period of 2000–2003. The study applies OLS and 2SLS regression estimations and finds that ownership concentration measured by the shareholding of five largest owners positively impacts firm performance. Interestingly, managerial shareholding is found to have a positive effect on financial performance of such Italian firms only when the ownership is non-concentrated, i.e. dispersed. The study concludes that large owners use their dominant position opportunistically by employing managers who work in line only with their personal interests. Moreover, Omran et al. (2008) make a sincere attempt to empirically identify determinants of ownership concentration and find out the relationship between ownership concentration and performance of 304 Arabian firms chosen from a variety of sectors of the economy. The study establishes that ownership concentration of Arabian companies is negatively related to the quality of legal protection. Therefore, ownership concentration is found to be more where legal protection is weak and vice versa. Besides, ownership concentration is not identified as a significant determinant financial performance of the sampled companies. In another study, Zeitun (2009) tries to interlink ownership structure with corporate performance and failure. The study constructs a sample taking 167 Jordanian companies for the period of 1989–2006. The study measures ownership concentration by considering two variables, one representing ownership by the largest five shareholders and another by using the Herfindahl index of ownership concentration. The study considers a shareholder’s holdings as concentrated only when it holds at least 5 percent of a company’s share. Besides, the study also uses a number of ownership structures like government ownership, institutional shareholding, etc. Applying the panel data regression model the study establishes that ownership concentration measured by ownership of the five largest shareholders

Ownership concentration and agency problem  67 is negatively correlated with firm performance measured by ROA and Tobin’s Q and positively correlated with MBVR. Besides, ownership concentration measured by the Herfindahl index is not found to have any significant correlation with any measures of corporate performance used in the study. However, institutional shareholding is found to have a negative relationship with corporate performance measured by ROA and positive relationship with MBVR. The study finally links a non-linear relationship between ownership concentration and performance of ­Jordanian companies. The study of Bruton et al. (2010) gives insights into the impact of concentrated ownership, types of block holders (namely, venture capitalists and business angels) and their effects on IPO performance in two nations, the U.K., a common law country, and France, a civil law country. The study supports the arguments of agency theory and states that concentrated ownership boosts IPOs’ performance. The research also shows that the impact on performance depends on the types of private equity investors and the countries’ legal environment. Business angels are found to have a significant value-enhancing effect on firms while venture capitalists have a negative effect on performance. Again, Margaritis and Psillaki (2010) examine how ownership structure plays an important role towards agency problem and financial performance of French manufacturing companies that belong to different industries. In the context of chemical industries, the study finds clear evidence in support of the hypothesis that firms having more ownership concentration suffer from less agency costs. However, the study does not document any statistically significant association between ownership structure and performance of companies belonging to textiles and computer industries. Looking at the lack of consensus among the researchers on the relationship between forms of ownership and performance of firms, Tsegba and Ezi-Herbert (2011) make a serious effort to carry out research on the issue in the context of 73 Nigerian listed companies of the Nigerian Stock Exchange. The study covers a period of 2001–2007 and applies the OLS method to arrive at the desired results. Based on the findings, the study concludes that dominant shareholders, ownership concentration and foreign equity ownership are not significantly related to the financial performance of Nigerian firms when measured by market price per share (MPS) and earnings per share (EPS). However, the study suggests an inverse relationship between insider ownership and firm performance. The researchers referring to the study results suggest that Nigerian corporates should rethink on the relevance and use of ownership types mentioned above as the corporate governance mechanisms for a firm. Besides, ownership by insiders is also recommended to be closely monitored and controlled in such firms. In a quite similar attempt, Stiglbauer (2011) studies the effect of ownership structure on corporate governance and performance of 80 German listed firms in 2007. The study finds an insignificant impact of ownership concentration on firm performance measures by return on equity (ROE). Besides, the study also establishes a negative relationship between free float and the MBVR and also free float and total shareholder return. Concurrently, Liang et al. (2011) examine the relationship between ownership and corporate financial performance from the perspective of Taiwan’s publicly

68  Ownership concentration and agency problem listed companies for the period of 1999–2008. Insider ownership concentration and institutional ownership concentration are considered as the independent variable. ROA and industry-adjusted ROA are introduced as performance variables. The Simultaneous Equations Model is used by the researchers to analyse the data collected on the sampled firms. The findings of the study confirm that institutional ownership, rather than insider ownership, is negatively and significantly related to the performance of Taiwanese listed firms. Again, Srivastava (2011) examines the effect of ownership pattern on the accounting and market performance of firms in the context of 98 companies listed and traded in the BSE 100 index of the Bombay Stock Exchange (BSE) of India. The study observes a high degree of ownership concentration in such Indian companies. Based on the regression results, the study documents a statistically significant association between a dispersed ownership pattern and the accounting performance of the sampled companies measured by ROA and ROE. However, the study does not find any evidence on the relationship between the ownership pattern and the market performance of the sampled companies. In a subsequent attempt, Fauzi and Locke (2012) examine the effect of various forms of ownership like managerial shareholding, directors shareholding, block holding, etc., on the performance of 79 listed companies of New Zealand belonging to six industries including primary, property, service, energy, goods and investment for the period of 2007–2011. The study considers ROA and Tobin’s Q as a proxy of firm performance. The results of the GMM estimation suggest that managerial ownership in such firms has a significant and positive impact on the performance measures. However, increase in block holdings is seen to exert an unfavourable impact on the performance of New Zealand firms. Besides, Mangena et al. (2012) conduct an empirical examination on the relationship between ownership concentration and few other corporate governance parameters on the performance of companies listed in the Zimbabwe Stock Exchange for the period of 2000–2005. The study splits the study period into pre- and post-presidential election periods, i.e. 2000–2002 and 2003–2005, to capture the effect of changes in the political landscape. The study applies system GMM estimation and finds a positive relationship between ownership concentration and performance of firms only during the post-presidential election period. The study based on its findings concludes that the nature of the companies’ political environment is a crucial determinant towards the relationship between ownership structure and firm performance in Zimbabwe. In a quite different approach, Kang and Kim (2012) in their study in China consider 6,588 non-financial firm-year observations from the firms listed on the Shenzhen Stock Exchange or Shanghai Stock Exchange from 1994 to 2002. The study tries to explore how change in ownership structure from purely government holding to partially government holding can affect firm performance. The partially government-controlled firms which they called marketized state-owned enterprises (MSOEs) were found to perform better than the purely government-controlled firms or state-owned enterprises (SOEs). Evidence was also found regarding the possibility of less expropriation of minority shareholders due to the presence of ownership concentration of a controlling shareholder.

Ownership concentration and agency problem  69 Looking at the rapid privatization in the Chinese economy, Huang and Boateng (2013) examine the impact of state ownership on the performance of the real estate sector; 101 firms listed on the Shenzhen and Shanghai Stock Exchange for the period of 1999–2010 are taken as the study sample. Moreover, the study period is further divided into two parts, one covers the booming period (2005–2010) and another covers the period before the boom (1999–2004). Proportion of the state shares, tradable A-shares, legal person shares, management shares and ownership concentration are used as the independent variables. The study uses Tobin’s Q to proxy firm performance. The study finds that relatively higher state shareholding is associated with poor performance in the pre-boom years and better performance in the booming years. On the other hand, legal person shareholdings, management shareholding and ownership concentration are found to positively influence the performance of Chinese real estate firms. At the same time, Caixe and Krauter (2013) document some crucial evidence relating to the non-linear impact of ownership concentration on the performance of 237 non-financial publicly traded firms from the Brazilian economy. The researchers use a study period of ten years which covers a period of 2001–2010. Applying dynamic regression estimation under the system GMM framework, the study finds that as the participation of the largest shareholder in cash flow rights increases, the market performance measured by Tobin’s Q of the Brazilian companies increases and the effect continues until the ownership by the largest shareholder touches 53.99 percent. For another performance measurement variable called enterprise value to total assets ratio, the optimum concentration is noted to be 51.85 percent. Therefore, the study concludes that in Brazilian non-financial companies, both the effect of ownership concentration, i.e. efficient monitoring, and minority shareholders’ expropriation co-exist. Later on, this study of Brendea (2014) investigates the impact of ownership concentration on the performance and capital structure in the context of 69 Romanian listed companies during the period 2007–2011. It involves a two-stage analysis, where in the first stage firm performance represented by ROA is considered as the exploratory variable and ownership concentration and debt-equity ratio are taken as the explanatory variables. In the second stage of the study, debt-equity ratio is considered as the exploratory variable and ROA and ownership concentration are taken as explanatory variables. In both the cases asset tangibility and firm size are considered as moderating variables. The findings of the study suggest that the effect of ownership concentration on firm performance is insignificant. However, the performance of Romanian firms is influenced positively by debt-equity ratio and firm size. In another attempt, the study of Dwaikat and Queiri (2014) focuses on establishing the empirical association between ownership structure, especially concentrated ownership structure and managerial shareholding, on the ROA and Tobin’s Q of 31 companies that are listed and traded on the Palestine Stock Exchange during 2008–2012. The study measures ownership concentration by taking the sum of total ownership by shareholders having at least 5 percent of stock ownership. The study finally finds that insider ownership measured by ownership of executive managers and directors has a significant and positive relationship with the financial

70  Ownership concentration and agency problem performance of companies measured by ROA and Tobin’s Q. The concentrated ownership structure is found to be negatively related with the performance measures of the sampled companies. Likewise, Vintila et al. (2014) undertake a panel data analysis for companies listed and traded on the Bucharest Stock Exchange to understand the effect of ownership concentration and ownership origin on the performance. The study confirms a non-linear relationship between the proportion of equity owned by the two largest owners and the three largest owners, when considered individually, and firm value. Regarding the ownership origin, the results provide evidence for a positive relationship between the residence of the largest shareholder and the value of firms. Again, in the context of Pakistan, Javeed and Azeem (2014) empirically test the impact of various parameters of corporate governance on firm value. The researchers also examine the statistical association between capital structure and corporate governance parameters. For the purpose of empirical analysis, 155 non-financial companies listed at the Karachi Stock Exchange for the period of 2008–2012 are sampled. Total debt to total assets (TDTA) ratio is taken as the proxy of capital structure. On the other hand, corporate governance of firm is measured based on board size, board independence, CEO duality, managerial ownership and ownership concentration. Finally, the dependent variable, i.e. firm value, is measured by using Tobin’s Q ratio. The study using panel regression estimation finds that in case of the parameters of corporate governance, only the board independence and ownership concentration measures are found to affect firm value significantly with a positive sign. Regarding the impact of leverage on governance measures, the study does not document any significant effect. The significance of ownership structure towards corporate performance is also the focal point of research of Soufeljil et al. (2016). The researchers for the purpose of the study construct a sample consisting of 51 companies listed and traded on the Tunis Stock Exchange from 2008 to 2012. The study documents a statistically significant and positive impact of ownership concentration on the performance of the sampled firm measured by ROA. Again, ownership by foreign investors and institutional investors’ shareholding are also found in the study to have a significantly positive impact on the performance of Tunisian companies during the considered study period. Again, the study of Najjar (2016) uses a sample consisting of 83 non-financial companies listed on the Amman Stock Exchange (ASE) for the period 2005–2013 to test the statistical relationship between ownership pattern and corporate performance. The study again corroborates a favourable impact of concentrated ownership structure on the value of Jordanian companies. In a quite distinct approach, the study of Wang (2016) in the context of the Chinese market approves a non-linear effect of block-holder ownership on corporate value. The study shows how the market value of companies first decreases with an increase in the proportion of block holdings and then improves as block holders own more equities. Abbasi et al. (2017) in the context of 78 firms listed and traded on the Tehran Stock Exchange for a period of seven years from 2007 to 2013 try to interlink ownership concentration with firm performance. The study based on multiple regression

Ownership concentration and agency problem  71 and panel data estimation techniques documents a statistically significant and positive association between ownership concentration and financial performance of the sampled companies. Quite similarly, the empirical investigation conducted by Yasser and Mamun (2017) introduces the Hirschman–Herfindahl index to proxy ownership concentration while interlinking it with performance in the context of Pakistan. The study finally approves the efficient monitoring role of majority owners and their positive contribution towards the economic profit and market-based performance of Pakistani companies. In the recent past, Mittal and Anjala (2018) explored the relationship between ownership structure and financial performance taking a sample of 178 non-financial companies listed and traded on the National Stock Exchange (NSE) of India for the period of 2008–2015. The study evidences a significantly positive impact of ownership concentration on firm performance and value. According to this research, a more substantial stake in the hands of promoters seems to foster greater access of funds for firms’ initial investment requirements and thereby results in a larger scale of operation resulting in improved firm performance. Besides, one of the eminent studies of the recent decade is carried out by Altaf and Saha (2018) in the context of India. The study using a sample of 236 Indian manufacturing firms tries to establish the nature of the empirical relationship between ownership concentration and firm value. The study also tries to understand how investors’ protection matters towards this ownership-value nexus. Using OLS, fixed effect model (FEM) and two-step GMM estimations, the study confirms a U-shaped relationship between ownership concentration and firm value. It is also interestingly documented that investor protection quality considerably moderates the ownership concentration-performance nexus in the Indian manufacturing sector. Most recently, Pandey and Sahu (2019) made an attempt to empirically establish the relationship between ownership concentration especially in the hands of promoters and the value of Indian manufacturing companies. The study measures the firm value of the sampled firms by using Tobin’s Q ratio. Based on panel data regression estimation, the study establishes a positive effect of concentrated ownership structure on the value of Indian manufacturing companies. The study finally concludes that in Indian manufacturing companies the giant promoters play a significant role in the form of efficient monitoring and controlling the activities of management and their opportunistic behaviour, which leads to better firm performance. Concluding remarks The researchers rigorously review the important and relevant studies among the vast set of literature existing in the domain of corporate finance and governance. The various research efforts at domestic and international academia directed towards the relationship between capital structure, ownership structure and corporate performance are extensively studied for the purpose of finding the research gap and developing the research questions. During the process of the literature survey, the researchers find a gamut of empirical studies undertaken in the aforesaid

72  Ownership concentration and agency problem directions, which are very much resourceful, insightful, enriching for the scholars of the domain. Some of the studies like Berle and Means (1932), Jensen and Meckling (1976), Grossman and Hart (1982), Myers (1977), etc., are recognized as path-breaking researches and are therefore very famous in the domain of corporate finance and governance. Among these, the study of Berle and Means (1932) and Jensen and Meckling (1976) are indeed the pioneering research in this domain of knowledge. Therefore, by acknowledging the invaluable research efforts undertaken by these and other researchers we identify some crucial research gaps, which we have tried to address in this empirical investigation. First, the extensive set of corporate governance literature fosters inconclusive findings and equivocal evidence regarding the relationship between capital structure, ownership structure, agency problem and performance of firms from different emerging and emerged markets’ perspectives. Another noteworthy point is that ownership concentration is mostly measured by three or five largest block holder(s). But, in India, the largest five block-holders may include a shareholder having a very insignificant stake in a firm; say, less than 5 percent. So, to be more practical, following Selarka (2005), this study sets a threshold of 5 percent for considering an ownership as concentrated. Besides, by introducing the Herfindahl-Hirschman index the study also captures the differential impact exerted by two large shareholders with different proportions of ownership in a firm (Curry and George, 1983). Lastly, during the literature review, it is found that most of the studies on capital structure, ownership structure and firm performance have applied quite erratic research methods and econometric techniques to arrive at the results. For example, as a major part of data analysis application of correlation, simple linear regression and static panel data approaches without robustness tests are mostly found. Considering the need for quite robust econometric analysis, the study introduces both the static panel data model and dynamic panel data estimation under the two-step GMM framework suggested by Arellano and Bond (1991). Another most crucial observation that we made during the review of the existing set of literature is that only a limited number of studies like Thomsen and Pedersen (2000), Earle et al. (2005), Caixe and Krauter (2013), etc., have considered the specific role of the largest shareholders on resolving or otherwise instigating agency problem, affecting operational efficiency and moderating corporate performance. This study finds it highly important, especially in case of the Indian manufacturing sector, to gauge the role played by largest shareholders on corporate performance and valuation. Having understood the importance of largest shareholder, the study tests the effect of the same on the performance of Indian manufacturing companies through the application of dynamic panel data estimation. Last but not the least, only a few studies devoted to the ownership-performance relationship have considered the non-linearity issue. Looking at the need to test the non-linear effect especially of ownership concentration on firm performance, the study also estimates as an extended analysis the quadratic relationship between the largest shareholding and firm performance under the dynamic panel data model.

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Ownership concentration and agency problem  75 Perrini, F., Rossi, G., & Rovetta, B. (2008). Does ownership structure affect performance? Evidence from the Italian market. Corporate Governance: An International Review, 16(4), 312–325. Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. The Journal of Finance, 54(2), 471–517. Roe, M. J. (2004). The institutions of corporate governance. Discussion Paper No. 488, Harvard Law School. Selarka, E. (2005). Ownership concentration and firm value: A study from the Indian ­corporate sector. Emerging Markets Finance and Trade, 41(6), 83–108. Shakir, R. (2008). Effect of block ownership on performance of Malaysian property companies. Pacific Rim Property Research Journal, 14(4), 361–382. Shleifer, A., & Vishny, R.W. (1988). Value maximization and the acquisition process. Journal of Economic Perspectives, 2(1), 7–20. Shleifer, A., & Vishny, R. W. (1986). Large shareholders and corporate control. Journal of Political Economy, 94(3), 461–488. Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737–783. Soufeljil, M., Sghaier, A., Kheireddine, H., & Mighri, Z. (2016). Ownership structure and corporate performance: the case of listed Tunisian firms. Journal of Business & Financial Affairs, 5(4), 1–8. Srivastava, A. (2011). Ownership structure and corporate performance: evidence from India. International Journal of Humanities and Social Science, 1(1), 23–29. Stiglbauer, M. (2011). Impact of capital and ownership structure on corporate governance and performance: evidence from an insider system. Problem and Perspective in Management, 9(1), 16–23. Thomsen, S., & Pedersen, T. (2000). Ownership structure and economic performance in the largest European companies. Strategic Management Journal, 21(6), 689–705. Tsegba, I. N., & Ezi-Herbert, W. (2011). The relationship between ownership structure and firm performance: evidence from Nigerian listed companies. African Journal of Accounting, Economics, Finance & Banking Research, 7(7), 51–63. Varma, J. R. (1997). Corporate governance in India: disciplining the dominant shareholder. IIMB Management Review, 9(4), 5–18. Vintila, G., Gherghina, S. C., & Nedelescu, M. (2014). The effects of ownership concentration and origin on listed firms’ value: empirical evidence from Romania. Romanian Journal of Economic Forecasting, 17(3), 51–71. Wang, B. (2016). Ownership, institutions and firm value: Cross provincial evidence from China. Working Paper No. 484, UK: Centre for Business Research, University of Cambridge. World Bank (1999). Corporate governance: a framework for implementation. Washington. Available at: https://doi.org/10.1596/0-8213-4741-1. Wruck, K. H. (1989). Equity ownership concentration and firm value: evidence from private equity financings. Journal of Financial Economics, 23(1), 3–28. Yasser, Q. R., & Mamun, A. A. (2017). The impact of ownership concentration on firm performance: evidence from an emerging market. Emerging Economy Studies, 3(1), 34–53. Zeitun, R. (2009). Ownership structure, corporate performance and failure: evidence from panel data of emerging market the case of Jordan. Corporate Ownership and Control, 6(4), 96–114.

5

Interaction among capital structure, equity ownership and corporate performance

Introduction In this chapter the authors have initiated data analysis to establish the empirical relationship between capital structure (CS), equity ownership structure and the financial performance of Indian manufacturing companies. However, before going to the analytical part of this study, a detailed description on the methodology followed to arrive at the study results needs to be discussed. Thus, in the next section of this chapter we give a detailed account of the nature of data used, sample design, construction of variables, model specifications, econometrics and statistical techniques including robustness tests that are adopted to get the research output. Below we discuss each of these aspects in a comprehensive way: Methodology Sample design includes the selection and size of the sample, the study period considered, various sources used for the collection of required data for the study, etc. We give a detailed description of each of the aspects below: Sample size and selection procedure

The study uses a set of strongly balanced panel data consisting of 86 manufacturing firms listed and traded on the BSE 200 index of the Bombay Stock Exchange (BSE) of India. Notably, the required data for 13 consecutive financial years were available for 86 manufacturing companies among 125 such companies initially selected for the sample. This is mostly because many companies have been amalgamated and acquired by other companies during this 13-year period. Besides, as we already mentioned in our first chapter that unlike other emerging markets of Asia, ownership concentration is much more noticeable in the manufacturing sectors in case of India (Selarka, 2005). Hence, studies on ownership structure and especially on concentration reasonably prefer manufacturing firms as the sample.

DOI: 10.4324/9781003397878-5

Capital structure, equity ownership and corporate performance  77 Study period

The study aims to provide some fresh empirical evidence on the relationship between CS, ownership structure and performance of Indian manufacturing firms. For the purpose of the study, the researcher covers a time period of 13 years from 2008 to 2020. Data sources

The data are collected from financial databases, namely, ‘Prowess’ and ‘ACE Equity’ developed by the Centre for Monitoring Indian Economy Pvt. Ltd and Accord Fintech Pvt. Ltd. respectively. Further, the study also uses annual reports of the sampled firms for different financial years. The required annual reports are sourced from the respective official websites of the companies. Besides, for the purpose, the website moneycontrol.com and that of the Securities and Exchange Board of India (SEBI) are also visited and found useful. The various financial and corporate governance-related reports, balance sheets, profit & loss accounts are surveyed from the respective websites to meet the data requirement. Variables used in the study

The study introduces a number of important variables to represent CS, ownership structure and firm performance of Indian manufacturing companies. Besides, a set of empirically endorsed and relevant firm-specific variables are introduced to control the effects of other possible determinants of corporate performance. Below the variables used in this study are described in detail: Dependent variables Return on assets (ROA)

The study uses ROA as one of the important proxies of the accounting performance of Indian manufacturing companies. ROA is commonly agreed to be a strong indicator of corporate accounting performance. ROA has been considered as a measure of firm performance in an innumerable number of empirical investigations like Zeitun and Tian (2007), Stiglbauer (2011), Bistrova et al. (2011), Pouraghajan et al. (2012). Return on equity (ROE)

The present study considers ROE as another measure of accounting performance of Indian manufacturing companies. ROE is also equally recognized as an important measure of companies’ accounting performance. The studies like Krishnan and Moyer (1997), Perrini et al. (2008), Bokhari and Khan (2013), Goyal (2013) have used ROE as a measure of firm performance. It signifies how efficient a firm is in

78  Capital structure, equity ownership and corporate performance generating returns on the investment it received from its equity shareholders. It is a ratio between net incomes to shareholders’ equity of a firm. Tobin’s Q (TQ)

Besides measuring accounting performance, the present study also measures the market performance or value of Indian manufacturing companies through TQ. TQ is the most frequently used measure of firm value in most of the past studies like Morck et al. (1988), Demsetz and Villalonga (2001), Vintila et al. (2014), Mishra and Kapil (2017), etc. The study following Ferreira and Matos (2008) and Ting (2013) measures TQ by dividing market capitalization plus total debt with the book value of total assets of a particular firm for a particular year. Market to book value ratio (MBVR)

The study also introduces MBVR as another measure of market performance of Indian manufacturing companies. MBVR is also used as an important proxy of firm value in a number of empirical researches like Zeitun and Tian (2007), Zeitun (2009), Stiglbauer (2011). Independent variables Capital structure

CS is one of the important variables in the study. The CS of Indian manufacturing companies is measured by taking the ratio of debt to equity. The debt-equity ratio is a very prominent and commonly used proxy of CS or financial leverage in the empirical investigations of corporate finance and governance. Firms’ financial leverage is in fact an important determinant of a firm’s profitability and agency costs (Grossman and Hart, 1986; Jensen, 1986; Stulz, 1990). Many empirical studies that attempt to interlink other corporate governance parameters and corporate performance also consider a firm’s financial leverage (mostly in the form of debt to equity ratio) as a control variable. Therefore, CS is both theoretically and empirically supposed to have crucial significance when it comes to the performance of firms. In this present study, we attempt to interlink CS measured by the debt-equity ratio and denoted by CS with the performance of Indian manufacturing companies. Ownership of domestic promoters (ODP)

ODP is measured by the percentage of ownership stake held by Indian promoters. Domestic promoters, by virtue of their considerable ownership rights, experience and expertise, are supposed to exert a positive influence on the financial performance of firms by actively monitoring the activities of management. The acronym used to denote ownership of domestic promoters is ODP.

Capital structure, equity ownership and corporate performance  79 Ownership of foreign promoters (OFP)

Quite similar to a domestic promoter, a foreign promoter is also supposed to be highly aware, knowledgeable and competent in monitoring the management of affairs of the firm in which he/she has invested. By working as an active monitor of the management foreign promoters are also supposed to influence the functioning and thereby financial performance of a corporation. In this present study, we consider foreign promoters’ ownership as one of the important ownership types which is attempted to interlink with the performance of Indian manufacturing companies. The variable ownership of foreign promoters is denoted by OFP in the study. Ownership of institutional investors (OIIN)

The category of institutional shareholders consists of banks, non-banking financial institutions, mutual fund companies, insurance companies, etc. These financial institutions keep professionally qualified and highly experienced investment experts who undertake a great deal of effort in terms of rigorous monitoring and active participation in the management of affairs of the invested company to ensure a good return on their investments. Therefore, institutional shareholding is another component of firm ownership that influences financial performance and valuation. In this study institutional ownership denoted by OIIN is also considered as an important proxy of ownership structure. Ownership concentration (OWN_CON)

The study, following Cubbin and Leech (1983), Demsetz and Lehn (1985), Bruton et al. (2010), Brendea (2014), introduces the Herfindahl-Hirschman index (HHI) to measure ownership concentration. The HHI as a variable is constructed by summing up the squares of the fractions of equity held by each shareholder with at least 5 percent ownership stake. The study considers a shareholder with at least 5 percent of ownership as large. Notably, simply summing up all the fractions of ownership by each shareholder with at least 5 percent of the shares implies a shareholder with 5 percent of shareholding and a shareholder with, say, 50 percent of ownership, as equally powerful in terms of the influence they exert in the management of affairs of a firm. The application of the HHI permits us to capture this difference. For example, for five shareholders with 20 percent of shareholdings each, the HHI will be 0.2, whereas for two shareholders with 50 percent of shareholdings each, the HHI will be 0.5. A higher HHI indicates higher ownership concentration and vice versa. Control variables Age of firms (AGE)

The age of firms, both theoretically and empirically, is known to have a very strong connection with their efficiency, level of profitability and valuation. The age of firms is correlated with operational efficiency and performance of firms in a number

80  Capital structure, equity ownership and corporate performance of empirical studies like Katz (1982), Hannan and Freeman (1984), Loderer and Waelchli (2010), etc. Therefore, this variable should be considered while modelling the relationship between CS, ownership structure and corporate performance. Firms’ liquidity (LQDT)

The theory of corporate finance advocates important implications of firms’ liquidity on operating efficiency and financial performance. The relationship is also sufficiently endorsed by a number of empirical investigations like Saleem and Rehman (2011), Niresh (2012), Lartey et al. (2013), etc. This study takes firms’ liquidity measured by quick ratio as a control variable. Therefore, in this research investigation liquidity measured by quick ratio is considered as an important firm-specific characteristic that is supposed to have a crucial bearing on the performance of companies. Assets utilization efficiency (AUE) of firms

The assets utilization efficiency is measured by the asset turnover ratio which is derived by dividing annual sales by the average total assets of firms. It represents how efficiently the management of a firm is utilizing its assets to generate sales (Ang et al., 2000) and thereby to enhance performance of firms. It also reflects the existence of agency problem between owners and managers and the monitoring efficiency of large owners towards easing out such problem. Asset turnover ratio (ATR) has been used as a popular proxy of agency problem in number of studies such as Li and Cui (2003), Matusin et al. (2014). As this variable has a direct association with the performance of companies, we introduce this variable as one of the control variables of this empirical investigation. Size of firms (FS)

The size of firms is an important moderating variable which is supposed to interact with the relationship between firm performance and any other variables. The firm size is used as a control variable in many important corporate governance studies like Farooque et al. (2007), Zeitun (2009), Santos et al. (2014), Maqbool and Zameen (2018). Following these empirical researches, in this present study we also include firm size in the set of control variables. The description of all the variables used is given in the Table 5.1. Research methods

The researcher adopts a very relevant and sophisticated research method to carry out this empirical study. The method includes a number of statistical and econometric tests and estimations. The researcher tries to arrive at meaningful, acceptable, reliable and robust results and for these purposes the study adopts those statistical and econometric tests which are highly recognized, accepted and widely known in the

Capital structure, equity ownership and corporate performance  81

Control Variables

Independent Variables

Dependent Variables

Table 5.1 Description of the Variables Variable

Acronym

Measurement

Return on Assets

ROA

Return on Equity

ROE

Tobin’s Q

TQ

Market to Book Value Ratio

MBVR

Ratio between net profit after tax of a firm and its average total assets investment Ratio between net profit after tax of a firm and average shareholders’ equity The ratio of market value of equity plus book value of debt to book value of total assets Ratio between market capitalization and net book value, where net book value = total assets value minus outside liabilities

Capital Structure Ownership of Domestic Promoters Ownership of Foreign Promoters Ownership of Institutional Investors

CS ODP

Ownership Concentration

OWN_CON

Lagged Dependent Variables

ROAit-1 ROEit-1 TQit-1 MBVRit-1

Age of Firms Firms’ Liquidity

AGE LQDT

Assets Utilization Efficiency of Firms Size of Firms

AUE

OFP OIIN

FS

Ratio of debt to equity capital Percentage of shares held by the Indian promoters Percentage of shares held by the foreign promoters Percentage of shares held by institutional investors like banks, nonbanking financial institutions, mutual fund companies, etc. HHI, a variable constructed by summing up the squares of the fractions of equity held by each shareholder with at least 5 percent ownership stake One-year lagged value of dependent variables (ROA, ROE, TQ and MBVR) Age of the firm since the establishment Quick ratio, a ratio of quick assets to current liabilities Asset turnover ratio, a ratio of annual sales to average total assets Natural logarithm of total assets

Source: Prepared by the researcher.

domain of social science research. The study first of all estimates the summary statistics including mean, median, standard deviation, maximum value and minimum value for each dependent, independent and control variable. Regarding inferential statistics, the study applies both static and dynamic panel data regression models along with the test of multicollinearity and the heteroskedasticity problem among the variables used in the study. The tests for multicollinearity and heteroskedasticity fall under the diagnostic test and are very crucial for ensuring that the results of the panel data analysis are not erroneous and spurious and therefore the inferences that are drawn based on the findings are correct, reliable and acceptable. Below,

82  Capital structure, equity ownership and corporate performance we give a detailed description of the various statistical and econometric tests used to arrive at the study results: Test of multicollinearity

One of the important assumptions of classical multivariate regression analysis is that the explanatory or independent variables are free from any significant correlation with one another. In other words, the non-existence of multicollinearity property among the variables is the assumption in a classical regression model. Technically, multicollinearity is a kind of data property in which two independent or explanatory variables in a multiple regression model are significantly correlated with each other and the degree of such correlation between the independent variables can be linearly estimated with a substantial degree of accuracy or precision. In such a phenomenon, the estimated coefficients of a multiple regression model respond and change erratically with a very small change in the regression model or the data used. Practically, multicollinearity is a condition of the predictor variables that are assumed to be nonstochastic. Moreover, multicollinearity is a feature or property of the sample used in a study rather than the population and for every sample its degree can be estimated. As we have already mentioned, the presence of multicollinearity property among the variables would lead researchers to spurious and erroneous results, which further results in ambiguous and unreliable research inferences. According to Gujarati (2004) there are specific reasons for which a classical regression model runs with the assumption of the non-existence of multicollinearity property among the explanatory variables. Below, we outline these crucial reasons as to why a classical regression model presumes the non-existence of multicollinearity property among the independent variables (Gujarati, 2004): • If in a regression model the data bears the perfect multicollinearity property, the regression coefficients of the independent or predictor variables estimated in the model would be indeterminate and their standard errors would also be infinite. • If in regression estimation the data set contains quite less than perfect multicollinearity, in such a case the regression coefficients of the explanatory variables so estimated would be determinate but would possess higher standard errors. Therefore, the accuracy and reliability of the estimation would become doubtful and questionable. The present study estimates the pair-wise correlation matrix and variance inflation factor (VIF) test to check the presence of multicollinearity. A brief description about these two tests is given below: Pair-wise correlation matrix

Estimating pair-wise correlations and presenting them in a correlation matrix is perhaps the simplest way of detecting and presenting the correlations between the set of explanatory variables of an empirical study. The purpose of introducing

Capital structure, equity ownership and corporate performance  83 this simple but useful econometric tool is to check the pair-wise correlations among the independent variables. In a pair-wise correlation matrix, if the correlation between any set of explanatory variables is found to be high and statistically significant then this phenomenon is supposed to distort the regression estimation. The correlation coefficients in a correlation test lie from −1 to +1. Generally, a statistically significant correlation coefficient of (−/+) 0.80 to (−/+) 1.00 indicates a very strong correlation between the variables and it can’t be overlooked. Generally, as a thump rule, a correlation coefficient up to 0.70 is treated as acceptable and avoidable. Variance inflation factor

The variance inflation factor, commonly called as VIF test, is another useful and reliable econometric test to detect the multicollinearity property among the independent variables. The value of VIF is calculated for each of the explanatory variables in a regression model as below: • First, the calculation of VIF value for an independent variable includes the calculation of R2 of the respective independent variable where R2 refers to the proportion of variance for a particular explanatory variable, which can be explained by all the other explanatory variables used in the regression model. • Now, VIF = 1/ (1–R2); where the values of VIF may range from 1 to infinite. In the equation of VIF, (1–R2) is known as the level of tolerance. Therefore, VIF is also referred to as 1/tolerance. • A VIF value 1 indicates that the concerned variable is not correlated with other independent variables. As the VIF value of a particular independent variable increases the degree of dependency also increases, which implies the presence of considerable multicollinearity. However, there is no formally prescribed criterion for determining the bottom line of the tolerance value of VIF but according to Gujarati (2004) explanatory variables can be regarded as highly collinear if the VIF value exceeds ten. Test of heteroskedasticity

As a diagnostic test, the test of heteroskedasticity is of equal importance in classical regression analysis. In simple terms, heteroskedasticity can be defined as a phenomenon in which the variability of a dependent variable under a regression model is found to be unequal across the range of values of a predicting variable. The opposite phenomenon is called homoskedasticity where the variability of the dependent variable is equal across values of an independent variable. Another way of understanding the problem of heteroskedasticity is that it’s a situation when the error terms of a regression model do not have constant variance.

84  Capital structure, equity ownership and corporate performance Now, it is very important to understand the factors that actually cause an increase in the heteroskedasticity problem in a regression model. Below, we outline a number of reasons as to why the problem of heteroskedasticity arises and increases: • The problem of heteroskedasticity may increase with an increase in the value of an independent variable. • The problem of heteroskedasticity may also become high when the value of an independent variable become more extreme in either direction, i.e. positive or negative. • Especially in the case of primary data, measurement error can cause an increase in the heteroskedasticity problem. • The problem of heteroskedasticity sometimes occurs due to sub-population differences or other interaction effects. For example, in establishing the relationship between income level on consumption, the effect of income level on consumption may differ for people of two different races like whites and blacks. • Sometimes an incorrect model specification can cause the heteroskedasticity problem to arise. For example, sometimes, a variable needs to be taken in log value or, say, in its squared term but if in that case the variable is taken in its absolute value then the model is mis-specified and it may bring in heteroskedasticity. Therefore, these are the crucial reasons which may cause the heteroskedasticity problem in a regression estimation to arise and increase. Notably, we must know that a regression model with this problem may have many undesirable consequences in an empirical investigation. For instance, in the presence of heteroskedasticity problem the simple regression estimation can’t be optimum. This is because with heteroskedasticity the model assigns equal weights to all the observations but in practice observations having larger disturbance variance contain less information in comparison to the observations having smaller disturbance variance. Besides, a regression model with a heteroskedasticity problem produces biased standard errors which further results in biased test statistics and confidence intervals. Thus, the existence of this problem may exert a serious effect on the model estimates and the inference drawn based on the estimations would lose their validity and reliability. Thus, the present study estimates the pair-wise correlation matrix and VIF for testing multicollinearity among the independent variables. The study also employs the Breusch-Pagan/Cook-Weisberg test for heteroskedasticity (Hettest) and the Information Matrix test (Imtest) for heteroskedasticity (White, 1980) for the test of heteroskedasticity problem. Static panel data analysis

The study first introduces static panel data analysis to establish the relationship between the set of dependent and independent variables. Panel data is the kind of data that contains time-series observations of a number of cross-sectional units. Therefore, it is a combination of time-series and cross-section data. The use of

Capital structure, equity ownership and corporate performance  85 panel data in empirical research has a number of advantages. If we go through the empirical investigations carried out for the last three decades, we can observe that a considerable research effort has been carried out pertaining to the theoretical issues and applications of the econometrics of panel data. Some of the notable advantages of using panel data are outlined below: • Better availability (Baltagi and Raj, 1992), less collinearity among the explanatory variables and increased efficiency of the economic estimators (Hsiao, 1985). • According to many authors, it allows the researchers to have a large number of observations, which leads to improved efficiency of econometric estimates. • According to Chamberlain (1984), Hsiao (1986), etc., panel data allows a researcher to undertake an in-depth analysis of complex economic hypotheses by controlling for influences corresponding to both individual and time heterogeneities. • Again, panel data allows us to control for variables that we cannot observe or measure, for example, variables that represent cultural factors or difference in business practices across firms. • According to Hsiao et al. (1995) in comparison to cross-sectional data, panel data usually contains more sample variability and degrees of freedom, which improves the accuracy of the econometric estimation. • Unlike cross-section or time-series data, use of panel data allows a researcher to capture the complexity in human behaviour in a comprehensive way. • Moreover, one of the important advantages of using panel data in empirical investigation is that for panel data estimations a number of sophisticated but easily available software like STATA, SHAZAM, LIMDEP, RATS, etc., are available: The static panel data analysis includes three regression models, namely, the ordinary least squares (OLS) model, the fixed effect model (FEM) and the random effect model (REM). The analysis also includes the selection of the best-fit regression model among these three models, because in panel data analysis it largely influences conclusions on the individual coefficients. In panel data, when the number of cross-sectional units is much larger than that of time-series units, as in the present case, the estimates obtained by FEM and REM differ significantly. Besides, all these three regression models run with different underlying assumptions. The OLS model assumes the intercept as well as the slope coefficients to be the same for all the 86 sample firms taken in the study. The FEM allows the intercepts to vary across the firms to incorporate special characteristics of the cross-sectional units. Finally, the REM assumes the intercept of a particular firm to be a random drawing from a large population which varies non-systematically with a constant mean value. As all these three conditions can’t prevail simultaneously, so the study needs to select an appropriate regression model. The study introduces restricted F-test, Breusch-Pagan Lagrange Multiplier (BP-LM) test suggested by Breusch

86  Capital structure, equity ownership and corporate performance and Pagan (1980) and Hausman test suggested by Hausman (1978) to have a judicious selection among the three regression models. The estimated models would be in the following form:

( ) ( ) ( ) ( ) β ( AGE ) + β ( LQDT ) + β ( AUE ) + β ( FS) + ε

ROA it = α + γ 1 CS + γ 2 ODP + γ 3 OFP + γ 4 OIIN + γ 5 (OWN_CON) + (5.1) 1

2

3

( ) ( ( ) (

)

4

(

) )

it

( ) ( )

ROE it = α + γ 1 CS + γ 2 ODP + γ 3 OFP + γ 4 OIIN + γ 5 (OWN_CON) + (5.2) β1 AGE + β 2 LQDT + β3 AUE + β 4 FS + ε it

)

(

( ) ( ) ( ) ( ) β ( AGE ) + β ( LQDT ) + β ( AUE ) + β ( FS) + ε

TQ it = α + γ 1 CS + γ 2 ODP + γ 3 OFP + γ 4 OIIN + γ 5 (OWN_CON) + 1

2

( )

3

(

4

)

(

)

(

it

)

MBVR it = α + γ 1 CS + γ 2 ODP + γ 3 OFP + γ 4 OIIN + γ 5

(

)

(

)

(5.3)

(

)

( )

(OWN_CON) + β1 AGE + β 2 LQDT + β3 AUE + β 4 FS + ε it

(5.4)

Here, ROAit and ROEit represent accounting performance of the ith firm at time period t, TQit and MBVRit refer to market performance of ith firm at time period t, α represents the constant terms in each equation separately, γ1 to γ5 represent the coefficients of capital and ownership structure variables respectively, β1 to β4 represent the coefficients of the control variables and εit represents the error terms in all the three models. Dynamic panel data estimation

Considering the dynamism of the relationship and bias caused by potential endogeneity of the explanatory variables, the study introduces the Arellano and Bond (1991) dynamic panel estimation technique that determines the joint effects of the explanatory variables on the explained variable while controlling for potential bias due to endogeneity of the explanatory variables including the lagged dependent variable. The dynamic panel data model is mostly preferred when the number of cross-section units is larger than that of time-series units, as in the present case. This is because of the fact that the estimation methods don’t require larger periods to obtain consistent parameter estimates (Mishra, 2008). The dynamic panel data regression model includes the lagged dependent variable as one of the independent variables with the supposition that the lagged dependent variable is correlated with the random disturbance term of the model and inclusion of it in the model accounts for the dynamic effects (Wintoki et al., 2012; Altaf and Shah, 2018). Notably, in such a situation when the lagged dependent variable is likely to be correlated with the error term of the model, the static panel data models like OLS and FEM become biased and thereby produce inconsistent estimates as these models largely ignore unobserved time-variant effects and the endogeneity of the dependent variable.

Capital structure, equity ownership and corporate performance  87 Therefore, following the previous literature we also take one-year lagged dependent variables as one of the independent variables to consider the dynamism of the relationship and to take into account the effect of some unobservable historical factors on the current dependent variable (Wooldridge, 2009). Some of the previous literature has considered instrumental variables in estimating the dynamic panel data model (Anderson and Hsiao, 1981; Bhargava and Sargan, 1983) but following Mishra (2008) we adopt the Arellano and Bond (1991) dynamic panel model, which is based on the generalized method of moments (GMM). Besides, according to Ahn and Schmidt (1995) the GMM estimator is likely to convey more information on data during the course of estimation than the method which includes instrumental variables. In the GMM method we control the potential bias due to endogeneity of independent variables by taking the one-year lagged value of the lagged dependent variable and other independent variables as instruments (Basant and Mishra, 2013). Additionally, the study introduces the Arellano-Bond test for autocorrelation and the Sargan (1958) test of over-identification to check the presence of autocorrelation and validity of the instruments used in the model respectively. Notably, there are two versions of the Arellano-Bond estimator, namely, the one-step and two-step estimator. The asymptotic standard errors of the one-step estimator are unbiased and more reliable to draw inferences on the individual coefficients but, at the same time, under this estimation the Sargan test over-rejects the null hypothesis of over-identification restriction in the presence of heteroskedasticity. Moreover, the robust standard error under one-step estimation can largely control the problem of heteroskedasticity but it can’t produce the Sargan statistic. Therefore, the researcher executes both the estimations wherein the researcher considers the individual coefficients of one-step estimation with robust standard error to draw inferences and the statistics of two-step estimation like the Sargan statistic, the Wald-Chi2 statistic to check the over-identification restriction and overall significance of the model respectively. In a nutshell, recognizing the dynamism of the relationship and the issue of endogeneity the researchers choose to extend the analysis from the static approach to the dynamic approach, which would ultimately lead to the most robust estimates and thereby strong inferences. Scheme of investigation

This subsection provides a brief description on the overall procedures followed by the researcher of this empirical study to arrive at the research outcomes. The study first constructs a strongly balanced panel data taking a sample of 86 manufacturing companies listed and traded on the BSE 200 index of BSE of India for the period of 2008–2020. The study sets a range of x̅ ± 2σ (where x̅ and σ stand for the sample mean and standard deviation of each variable respectively) to eliminate the outliers from the panel data set to avoid a distortion in results. For the purpose of the analysis of the collected data, the study employs both descriptive and inferential statistics. Under descriptive statistics, the researcher tries to understand the basic property of the variables by estimating measures of central tendency like

88  Capital structure, equity ownership and corporate performance mean, median and measures of dispersion like standard deviation, minimum and maximum value. Now, before going to mainstream data analysis, the study checks the presence of multicollinearity property and the heteroskedasticity problem. To test the presence of multicollinearity property the study uses pair-wise correlation matrix and VIF whereas to detect the heteroskedasticity problem the study employs Breusch-Pagan/Cook-Weisberg test (Hettest) and the Information Matrix test (Imtest) for heteroskedasticity. The study employs two versions of panel data regression analysis. First, it introduces a static panel data approach under which results of the OLS model, FEM and REM are estimated. The study further employs the restricted F-test, the BreuschPagan Lagrange Multiplier test and the Hausman test to make a judicious selection among these three regression models. Besides, considering the dynamism of the relationship and the bias caused by potential endogeneity of the explanatory variables the researcher estimates the Arellano and Bond (1991) dynamic panel estimation technique, which is based on GMM. Under dynamic panel data analysis, the researcher gets the one-step and two-step estimator and executes both the estimations wherein the researcher considers the individual coefficients of one-step estimation with robust standard error for the purpose of drawing inferences. The researcher uses the statistics of two-step estimation like the Sargan statistic and the Wald-Chi2 statistic to check the over-identification restriction and overall significance of the model respectively. Empirical results This section of the chapter presents the most vital part of this research. The section contains the empirical results of both descriptive statistics and inferential statistics. The section presents a very comprehensive summary statistics table which helps us to understand the basic data property like central tendency and dispersion of the variables used in this research. The descriptive statistics include the means, standard deviation values, minimum values and maximum values of all the variables under consideration. From the mean values of the variables, we can understand the average quantitative position of the Indian manufacturing companies with respect to that variable. The standard deviation value would indicate the degree of dispersion or deviation among the companies with respect to the values of a particular variable. The minimum and maximum values would show the range within which the value of a variable lies. Now, after estimating the descriptive statistics, the study before proceeding to the panel data estimation, check for multicollinearity and heteroskedasticity as the diagnostic test. Finally, the nature and degree of the empirical relationship between CS, ownership structure and corporate performance is examined through inferential statistics. Regarding inferential statistics, the study applies static and dynamic panel data models to arrive at the results. The application of dynamic panel estimation under the GMM framework is highly expected to ensure the reliability and robustness of the results that the study would obtain. Beside the mainstream analysis, the study at last carries out an additional or extended analysis in Chapter 6 by introducing a new independent variable of ownership structure, i.e. largest ownership, and testing the non-linear effect of this variable on the performance measures of the study.

Capital structure, equity ownership and corporate performance  89 Descriptive statistics

Table 5.2 represents the descriptive statistics of the variables included in the regression models. The mean debt to equity ratio of Indian manufacturing firms is found to be 0.44. It means the owners’ capital in these firms on an average is two times of their debt capital. However, the deviation in debt to equity ratio is not very high, which indicates that the magnitude of financial leverage among Indian manufacturing firms is not so dispersed. Among the different kinds of shareholders, the average domestic promoters’ shareholdings in Indian manufacturing firms is found to be highest, i.e. 44.41 percent. The maximum ownership by domestic promoters is found to be 90.40, signifying the dominance of large promoters in the ownership of Indian manufacturing firms. However, the average shareholding by foreign promoters in the firms is found to be 2.66 with a maximum value of 41.23. Therefore, on an average the ownership interest of foreign promoters in Indian manufacturing companies is seen to be not so high. The average percentage of shareholding held by institutional investors is 29.35, implying considerable participation of banks, insurance, mutual funds, etc., companies on the equity ownership of such firms. Considering the performance dimension of Indian firms, we observe that the average accounting performance of Indian firms is good enough as the mean values of ROA and ROE are found to be 9.58 and 18.50 percent respectively. More specifically, it represents the capacity of the sampled firms in wisely using its assets and equity capital respectively. The mean TQ is found to be 2.29 percent, which indicates that the market value of Indian manufacturing firms on an average is more than two times of their book value. Besides, the mean MBVR of 4.08 also implies good market performance of such firms.

Table 5.2 Descriptive Statistics Variable

Mean

Standard Deviation

CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS ROA ROE TQ MBVR

0.44 44.41 2.66 29.35 0.15 42.70 1.19 0.92 9.09 9.58 18.50 2.29 4.08

0.50 22.89 7.83 10.35 0.13 19.79 0.76 0.52 1.24 6.93 14.42 1.66 3.21

Source: Calculated by the researcher.

Minimum Value Maximum Value 0.00 0.00 0.00 6.18 0.000 8.00 0.09 0.02 6.34 –9.60 –67.97 0.17 0.03

2.29 90.40 41.23 53.15 0.55 97.00 4.24 2.32 11.95 29.66 99.11 7.96 15.13

90  Capital structure, equity ownership and corporate performance Diagnostic tests

The presence of multicollinearity property among the variables can produce erroneous results and lead to spurious inferences. The study introduces the pairwise correlation matrix and VIF (Table 5.3) to check the presence of multicollinearity. Though the pair-wise correlations are in some cases found to be quite high (e.g. –0.49 between OIIN and ODP), considering the VIF values of the explanatory variables used in this study it is assured that they are free from severe multicollinearity. Most of the correlations are found to be very low and even insignificant for some pairs of variables whereas the maximum VIF value is found to be 4.05. As we know, there is no such commonly agreed criterion for determining the bottom line of the tolerance value of VIF; however, according to Gujarati (2004) explanatory variables can be regarded as highly collinear if the VIF value exceeds ten. Besides, the classical regression model assumes that the modelling errors or error terms are uncorrelated and uniform and the variance of such error terms is constant, which fits under a condition of homoskedasticity. Now, when the error terms do not have constant variance, they are said to be heteroskedastic and the existence of this problem is a serious concern in the application of regression analysis as it can invalidate statistical tests of significance. Therefore, regarding heteroskedasticity, the study introduces two tests, namely, the Breusch-Pagan/Cook-Weisberg test for heteroskedasticity (Hettest) and the Information Matrix test (Imtest) for heteroskedasticity (White, 1980). The results of Hettest and Imtest test as depicted in Table 5.4 confirm that almost all four models suffer from heteroskedasticity. Hence, to control the adverse effect of the heteroskedasticity problem the study applies robust standard errors (White, 1980) while computing the individual coefficients through the regression models to make the best linear unbiased estimator.

Table 5.3 Pair-wise Correlation Matrix and VIF Ind Var CS CS ODP OFP OIIN OWN_ CON AGE LQDT AUE FS

ODP

OFP

OIIN

OWN_ AGE CON

LQDT

AUE

FS

VIF

1.00 0.08*** –0.02 –0.08*** –0.08**

1.00 –0.32*** 1.00 –0.49*** –0.14*** 1.00 0.26*** –0.02 –0.29*** 1.00

1.26 4.05 2.40 3.05 1.65

–0.15*** –0.27*** –0.07** 0.17***

–0.17*** 0.10*** –0.20*** –0.04

1.09 1.15 1.30 1.51

–0.02 0.04 0.24*** –0.18***

0.08** –0.06* –0.07** 0.25***

–0.03 1.00 –0.01 –0.06* 1.00 –0.08** 0.03 –0.13*** 1.00 0.10*** 0.03 –0.15*** –0.39*** 1.00

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance.

Capital structure, equity ownership and corporate performance  91 Panel data analysis

The study, after confirming the non-existence of multicollinearity and resolving the heteroskedasticity problem, proceeds to panel data regression analysis. For our first estimation model which regresses ROA with the CS and ownership structure variables along with a set of control variables, the F-statistic of OLS and FEM and the Wald-χ2 statistic of REM is found to be significant at 1 percent level (Table 5.5). Furthermore, the restricted F-test statistic [F (70, 622) = 11.60***], the BP-LM test statistic [χ2 (1) = 536.62***] and the Hausman test statistic [χ2 (9) = 187.54***] are all found to be highly significant (Table 5.6). The restricted F-test chooses FEM over OLS, the BP-LM test chooses REM over OLS and the Hausman test selects FEM Table 5.4 Test of Heteroskedasticity Test

Regression Model

Results

Breusch-Pagan/ Model 1 (Dependent variable: ROA) Cook-Weisberg test Model 2 (Dependent variable: ROE) Model 3 (Dependent variable: TQ) Model 4 (Dependent variable: MBVR) White’s Information Model 1 (Dependent variable: ROA) Matrix test Model 2 (Dependent variable: ROE) Model 3 (Dependent variable: TQ) Model 2 (Dependent variable: MBVR)

Chi2 (1) = 4.06** Chi2 (1) = 0.20 Chi2 (1) = 74.98*** Chi2 (1) = 68.41*** Chi2 (54) = 148.63*** Chi2 (54) = 75.38** Chi2 (54) = 168.45*** Chi2 (54) = 180.98***

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance.

Table 5.5 Panel Regression Results (Dependent Variable: ROA) Ordinary Least Squares Model Coefficient t-Stat Intercept 7.86 CS –4.83 ODP 0.16 OFP 0.08 OIIN 0.11 OWN_CON –10.67 AGE –0.004 LQDT 1.69 AUE 3.73 FS –1.29 F-Stat 85.34*** Wald-χ2 R2 0.54

2.96*** –12.37*** 7.42*** 2.59*** 4.07*** –5.48*** –0.45 5.87*** 9.57*** –7.03***

Fixed Effect Model Coefficient t-Stat 8.26 –3.63 0.03 0.26 0.13 2.41 –0.16 1.58 8.08 –0.72 45.61*** 0.40

1.92* –7.48*** 0.66 2.09** 4.56*** 0.67 –2.21** 6.93*** 11.59*** –1.32

Random Effect Model Coefficient z-Stat 9.84 –3.63 0.10 0.03 0.13 –1.35 –0.01 1.57 6.30 –1.65

2.95*** –8.38*** 3.32*** 0.56 4.61*** –0.49 –0.50 7.10*** 11.38*** –5.98***

451.67*** 0.49

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 per cent level of significance.

92  Capital structure, equity ownership and corporate performance Table 5.6 Selection of Appropriate Model from Table 5.5 Purpose

Null Hypothesis

Ordinary Least Squares Model All ui = 0 vs Fixed Effect Model Ordinary Least Squares Model σ2u = 0 vs Random Effect Model Fixed Effect Model vs Random Difference in Effect Model coefficients is not systematic

Test

Test Statistic

Restricted F-Test

F (70, 622) = 11.60*** χ2(1) = 536.62***

Breusch-Pagan Lagrange Multiplier Test Hausman Test

χ2(9) = 187.54***

Source: Calculated by the researcher. Note: * Denotes 1 percent level of significance.

over REM. Therefore, we find FEM as the best-fit regression model for establishing a relationship between the variables. It has already been discussed in the Research Methods subsection of this chapter that the FEM as a static panel data analysis can’t control the potential bias that arises due to endogeneity problem and therefore the results produced under this model must not be treated as robust. Therefore, to consider the dynamism of the relationship and to eliminate the bias caused by potential endogeneity of the explanatory variables including the lagged dependent variable the study estimates the Arellano and Bond (1991) dynamic panel estimation technique. The dynamic panel regression model including one-step and two-step estimations are presented in Table 5.7. The Arellano and Bond (1991) dynamic panel estimation also includes test for the validity of the instruments used and the autocorrelation problem in the model used. The Sargan test for the over-identification statistic is found to be insignificant, implying that our estimation models do not suffer from the problem of over-identification restrictions. The underlying null hypothesis of the test can’t be rejected, which means the instruments used in the estimations are valid, implying that these instruments are not correlated with the error term (Mahakud and Misra, 2009). The Arellano-Bond AR (1) test for first-order autocorrelation is found significant; however, AR (2) is found to be insignificant, which implies that our model is free from second-order autocorrelation problem and for system GMM we can proceed with this condition (Kathavate and Mallik, 2012). Again, the highly significant Wald-Chi2 statistics of one- and two-step estimations confirm that both the models are statistically significant. It is already mentioned that the z-statistics of regression coefficients produced by step one are based on robust standard error and hence the study only considers these coefficients for the purpose of testing our hypotheses and drawing subsequent inferences. From Tables 5.8 to 5.16, the same procedure is followed for the other three regression models with ROE, TQ and MBVR as dependent variables respectively. In all such cases, the FEM models are found to be the best fit in the static panel data analyses. Again, in the same way as before, the study considers the z-statistics of regression coefficients produced by the step-one estimator under dynamic panel data analysis.

Capital structure, equity ownership and corporate performance  93 Table 5.7 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: ROA) Variables Intercept ROAit-1 CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS Wald-Chi2 Sargan Test for over-identification Arellano-Bond Test for AR (1) Arellano-Bond Test for AR (2)

One-Step Estimates

Two-Step Estimates

Coefficient z-Stat

Coefficient z-Stat

3.08 0.12 –4.30 0.05 0.26 0.14 –7.84 –0.10 1.28 8.33 –0.46 117.38***

10.08 1.75* 0.14 1.95* –4.54 –4.88*** 0.02 0.37 0.20 2.44** 0.14 3.54*** –0.41 –0.06 –0.18 –1.27 0.87 2.98*** 7.54 6.39*** –0.76 –0.80 185.13*** 14.21 (p = 0.1637) –3.88*** (p = 0.0001) –0.88 (p = 0.38)

0.43 1.35 –3.96*** 0.70 3.05*** 3.12*** –0.84 –0.62 3.58*** 5.94*** –0.39

–3.78***(p = 0.0002) –1.04 (p=0.30)

Source: Calculated by the researcher. Notes i. *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance. ii. z-Statistics in one-step estimation are based on robust standard error to control for heteroskedasticity and autocorrelation.

Table 5.8 Panel Regression Results (Dependent Variable: ROE) Ordinary Least Squares Model Coefficient t-Stat Intercept CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS F-Stat Wald-χ2 R2

22.15 –3.41 0.16 0.002 0.16 –7.13 –0.01 1.69 11.74 –3.00 41.17***

3.81*** –3.65*** 3.26*** 0.02 2.44** –1.73* –0.72 3.26*** 11.79*** –7.26***

0.43

Fixed Effect Model Coefficient t-Stat 31.76 –4.52 0.11 0.48 0.25 14.70 –0.98 1.67 19.47 –0.71 57.65*** 0.45

3.13*** –3.90*** 0.99 1.94* 3.63*** 1.73* –5.63*** 3.16*** 12.01*** –0.55

Random Effect Model Coefficient z-Stat 38.81 –2.43 0.07 –0.05 0.20 9.09 –0.09 1.70 16.65 –4.95

4.98*** –2.35** 1.05 –0.41 3.06*** 1.41 –1.96** 3.25*** 13.00*** –7.71***

458.45*** 0.41

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance.

94  Capital structure, equity ownership and corporate performance Table 5.9  Selection of Appropriate Model from Table 5.8 Purpose

Null Hypothesis

Test

Test Statistic

Ordinary Least Squares Model vs Fixed Effect Model Ordinary Least Squares Model vs Random Effect Model Fixed Effect Model vs Random Effect Model

All ui = 0

Restricted F-Test

F (70, 632) = 9.94***

σ2u = 0

Breusch-Pagan Lagrange Multiplier Test Hausman Test

χ2(1) = 345.12***

Difference in coefficients is not systematic

χ2(9) = 94.73***

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance.

Table 5.10 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: ROE) Variables Intercept ROEit-1 CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS Wald-Chi2 Sargan Test for over-identification Arellano-Bond Test for AR (1) Arellano-Bond Test for AR (2)

One-Step Estimates

Two-Step Estimates

Coefficient

z-Stat

Coefficient

z-Stat

19.86 0.02 –10.59 0.18 0.14 0.26 –21.81 –1.93 1.70 17.69 5.81 136.80***

0.96 0.19 –3.49*** 0.99 0.45 1.83* –1.21 –3.21*** 2.15** 6.06*** 1.30

25.63 1.66* –0.05 –0.73 –11.11 –4.49*** 0.32 1.93* 0.08 0.27 0.27 2.46** –23.28 –1.44 –1.53 –3.03*** 0.59 0.93 18.18 7.84*** 2.94 0.87 198.64*** 14.63 (p = 0.1462)

–2.83*** (p = 0.0047)

–2.49** (p = 0.0126)

–1.54 (p = 0.1231)

–1.47 (p = 0.1410)

Source: Calculated by the researcher. Notes i. *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance. ii. z-Statistics in one-step estimation are based on robust standard error to control for heteroskedasticity and autocorrelation.

Capital structure, equity ownership and corporate performance  95 Table 5.11  Panel Regression Results (Dependent Variable: TQ) Ordinary Least Squares Model

Intercept CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS F-Stat Wald-χ2 R2

Fixed Effect Model

Coefficient t-Stat

Coefficient t-Stat

–0.68 –1.17 0.08 0.08 0.04 –5.45 –0.001 0.01 0.43 –0.13 44.75***

–4.27 –0.68 0.04 0.09 0.05 –0.41 0.005 0.12 0.57 0.24 11.74***

–1.01 –11.09*** 12.25*** 9.67*** 6.00*** –9.37*** –0.42 0.18 4.05*** –2.60***

0.44

–3.17*** –4.53*** 3.02*** 3.43*** 5.39*** –0.36 0.23 1.70* 2.55** 1.40

Random Effect Model Coefficient z-Stat –2.81 –0.94 0.08 0.09 0.05 –3.89 0.002 0.03 0.48 0.01

–2.97*** –7.26*** 9.06*** 7.37*** 6.37*** –5.05*** 0.39 0.39 3.08*** 0.19

195.11*** 0.41

0.15

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance.

Table 5.12  Selection of Appropriate Model from Table 5.11 Purpose

Null Hypothesis

Test

Test Statistic

Ordinary Least Squares Model vs Fixed Effect Model Ordinary Least Squares Model vs Random Effect Model

All ui = 0

F (70, 589) = 6.83***

Fixed Effect Model vs Random Effect Model

Difference in coefficients is not systematic

Restricted F-test Breusch-Pagan Lagrange Multiplier test Hausman test

σ2u = 0

χ2(1) = 272.13*** χ2(9) = 57.68***

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance.

Table 5.13  Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: TQ) Variables Intercept TQit-1 CS ODP OFP OIIN

One-Step Estimates

Two-Step Estimates

Coefficient z-Stat

Coefficient z-Stat

3.44 0.27 –0.60 0.01 0.07 0.05

3.70 0.24 –0.47 0.01 0.07 0.05

1.87* 3.76*** –2.24** 0.46 2.82*** 3.44***

2.27** 5.55*** –1.99** 0.55 2.86*** 4.03*** (Continued)

96  Capital structure, equity ownership and corporate performance Table 5.13  (Continued) One-Step Estimates

Variables OWN_CON AGE LQDT AUE FS Wald-Chi2 Sargan Test for Over-identification Arellano-Bond Test for AR (1) Arellano-Bond Test for AR (2)

Two-Step Estimates

Coefficient z-Stat

Coefficient z-Stat

1.45 0.14 –0.01 0.02 –1.08 131.95***

0.03 0.02 0.10 2.69*** 0.11 0.93 0.31 0.85 –0.96 –4.51*** 230.37*** 15.15 (p = 0.1268) –3.83*** (p = 0.0001) –0.51 (p = 0.6074)

0.61 2.88*** –0.11 0.06 –3.91***

–3.69*** (p = 0.0002) –0.44 (p = 0.6601)

Source: Calculated by the researcher. Notes i. *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance;* denotes 10 percent level of significance. ii. z-Statistics in one-step estimation are based on robust standard error to control for heteroskedasticity and autocorrelation.

Table 5.14 Panel Regression Results (Dependent Variable: MBVR) Ordinary Least Squares Model Coefficient Intercept CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS F-Stat Wald-χ2 R2

–3.93 –1.60 0.15 0.16 0.07 –9.90 0.0002 –0.38 1.83 –0.09 38.54***

t-Stat –2.82*** –6.53*** 11.52*** 8.53*** 4.93*** –8.65*** 0.03 –2.70*** 7.61*** –0.90

0.43

Fixed Effect Model Coefficient

t-Stat

–8.59 –0.61 0.11 0.19 0.08 –3.49 0.003 –0.08 2.05 0.38 8.04***

–3.17*** –2.01** 3.60*** 3.60*** 4.66*** –1.54 0.07 –0.54 4.62*** 1.11

0.11

Random Effect Model Coefficient –6.75 –1.02 0.14 0.17 0.09 –7.53 0.005 –0.22 1.91 0.08

z-Stat –3.48*** –3.92*** 8.37*** 6.57*** 5.47*** –4.75*** 0.47 –1.65* 5.93*** 0.51

162.21*** 0.42

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance.

Capital structure, equity ownership and corporate performance  97 Table 5.15 Selection of Appropriate Model from Table 5.14 Purpose

Null Hypothesis Test

Ordinary Least Squares Model All ui = 0 vs Fixed Effect Model Ordinary Least Squares Model σ2u = 0 vs Random Effect Model Fixed Effect Model vs Random Effect Model

Difference in coefficients is not systematic

Test Statistic

Restricted F (70, 609) = 7.28*** F-test Breusch-Pagan χ2(1) = 370.14*** Lagrange Multiplier test Hausman test χ2(9) = 22.94***

Source: Calculated by the researcher. Note: *** Denotes 1 percent level of significance.

Table 5.16 Results of the Arellano-Bond Dynamic Panel Data Model (Dependent Variable: MBVR) Variables Intercept MBVRit-1 CS ODP OFP OIIN OWN_CON AGE LQDT AUE FS Wald-Chi2 Sargan Test for over-identification Arellano-Bond Test for AR (1) Arellano-Bond Test for AR (2)

One-Step Estimates Coefficient –0.17 0.08 –0.06 0.08 0.11 0.12 –4.02 0.20 –0.31 1.82 –1.41 44.96***

z-Stat –0.04 0.67 –0.15 1.91* 1.66* 4.18*** –0.88 2.26** –1.05 2.88*** –2.49**

–3.22*** (p = 0.0013) –0.41 (p =0.6833)

Two-Step Estimates Coefficient

z-Stat

5.22 1.65* 0.08 1.30 –0.55 –1.52 0.07 1.91* 0.10 1.75* 0.10 3.81*** –0.87 –0.24 0.17 2.79*** –0.12 –0.59 1.31 2.52** –1.80 –4.01*** 57.52*** 15.02 (p = 0.1313) –3.26*** (p = 0.0011) –0.22 (p = 0.8247)

Source: Calculated by the researcher. Notes i. *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance. ii. z-Statistics in one-step estimation are based on robust standard error to control for heteroskedasticity and autocorrelation.

Findings of the study

Based on panel data regression analysis, which includes the static and dynamic panel data estimations, the study obtains a number of crucial findings relating to the effect of CS, ownership structure and a set of firm-specific characteristics on the accounting and market-related performance of BSE listed manufacturing companies in India. The findings in regard to the independent variables are as follows:

98  Capital structure, equity ownership and corporate performance CS and corporate financial performance

The study frames the null hypothesis that ‘there is no relationship between capital structure and corporate performance’. The panel data estimation establishes a statistically significant relationship between CS and firm performance. Both the static and dynamic models of panel data estimation approve that the CS of Indian manufacturing companies has a crucial bearing on their financial performance. To be specific, CS measured by debt-equity ratio is found to be negatively related with the accounting and market performance of Indian manufacturing companies. CS is found to have a negative effect on both the proxies used for accounting performance, i.e. ROA and ROE. The coefficients against ROA in the static and dynamic panel estimations are found to be –3.63 and –4.30 respectively at 1 percent level of significance. The coefficients against ROE in the same models are found to be –4.52 and –10.59 at 1 percent level of significance. Regarding market performance, the coefficients for TQ are found to be negative and statistically significant at both the estimation models. The effect of CS on the market performance measured by MBVR is found to be statistically significant only in case of fixed effect estimation. The relationship is again found to be negative (coefficient = –0.61) with 5 percent level of significance. Therefore, based on the findings of the panel data estimation on the relationship between CS and firm performance, it can be inferred that the use of borrowed capital ultimately exerts an unfavourable impact on the operational efficiency and performance of Indian manufacturing companies. In other words, Indian manufacturing firms are found to be profitable and value-creating when they rely more on owners’ funds instead of borrowed funds. We will explore the possible reason and justification behind the negative impact of CS on firm performance later on in Chapter 7. Thus, based on the results of panel data estimations, the study fails to accept the first null hypothesis and infers that CS of Indian manufacturing companies is significantly related to their financial performance. Ownership structure and corporate financial performance

The effect of equity ownership structure on firm performance is examined by introducing a number of ownership forms which include ODP, OFP and OIIN. Notably, for the sake of convenience in modelling and estimation, we have taken the ownership concentration variable measured by HHI in our regression estimations but considering the importance of the matter we have devoted a separate chapter to discuss the empirical findings regarding the effect of concentration on firm performance. Now, the specific effect that each of these ownership forms exerts on the financial performance of the sampled firms is discussed below: ODP and corporate performance

Regarding the effect of ODP on the accounting and market-related performance measures of Indian manufacturing companies it is evidenced that only the market performance of companies is affected by the size of the domestic promoter’s

Capital structure, equity ownership and corporate performance  99 ownership. To be specific, the coefficients against the accounting performance measures, i.e. ROE and ROE, are found to be statistically insignificant for both the kinds of panel data estimations. Taking TQ and MBVR as dependent variables, the FEM models report positive coefficients (i.e. 0.04 and 0.11 respectively) with 1 percent level of significance. The one-step estimation under the dynamic model only reports a significant and positive effect of ODP on MBVR with 10 percent level of significance. Thus, based on the study findings it can be inferred that Indian promoters exert a positive but marginal influence only on the market performance of Indian manufacturing companies. OFP and corporate performance

Regarding the relationship between foreign promoters’ shareholding and firm performance, both the types of panel data estimations suggest a positive impact on the accounting performance and market performance of Indian manufacturing companies. The coefficients of OFP under FEM for ROA and ROE are found to be 0.26 and 0.48 with 5 and 10 percent level of significance respectively. Besides, the one-step estimation in the dynamic model reports positive coefficients for ROA. The coefficients against market performance measures, i.e. TQ and MBVR, are found to be positive and statistically significant in both the types of estimations (Table 5.11, 5.13, 5.14 and 5.16). Therefore, almost all the variables used to measure the accounting and market performance of our sampled firms are found to be affected by the changes in the scale of ownership by foreign promoters. Thus, it can definitely be inferred from the results of the panel estimation that foreign promoters’ expertise is indeed useful towards the monitoring and controlling of managerial discretionary expenses and opportunistic use of firms’ resources by management. Besides, the increase of foreign promoters’ participation in the ownership and control of Indian manufacturing companies also seems to create value for them. OIIN and corporate performance

Ownership by institutional investors is found to have a positive impact on all the variables used to represent the accounting and market performance of the sampled firms for both the estimation techniques (Tables 5.5, 5.7, 5.8, 5.10, 5.11, 5.13, 5.14, 5.16). Therefore, the contribution of institutional investors like banks, non-banking financial companies (NBFCs), mutual funds and insurance companies, etc., in closely supervising the management of affairs and thereby neutralizing the owner-managers’ agency problem in Indian manufacturing companies is quite confirmed. Moreover, this is the only variable among the set of independent variables considered in the study which is found to have a significant impact on all the measures of financial performance. Concluding remarks The authors in this chapter have made an attempt to establish the empirical association between CS and various form of equity ownership on the performance of 86

100  Capital structure, equity ownership and corporate performance manufacturing firms in the context of India. The results obtained from the panel data estimation report significant statistical relationship between the variables. Especially, the institutional ownership as a form of equity ownership is found to affect all the measures of corporate financial performance. References Ahn, S. C., & Schmidt, P. (1995). Efficient estimation of models for dynamic panel data. Journal of Econometrics, 68(1), 5–27. Altaf, N., & Shah, F. A. (2018). Ownership concentration and firm performance in Indian firms: does investor protection quality matter? Journal of Indian Business Research, 10(1), 33–52. Anderson, T. W., & Hsiao, C. (1981). Estimation of dynamic models with error components. Journal of the American Statistical Association, 76(375), 598–606. Ang, J. S., Cole, R. A., & Lin, J. W. (2000). Agency costs and ownership structure. The Journal of Finance, 55(1), 81–106. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. Baltagi, B. H., & Raj, B. (1992). A survey of recent theoretical developments in the econometrics of panel data. Empirical Economics, 17(1), 85–109. Basant, R., & Mishra, P. (2013). Concentration and other determinants of innovative efforts in Indian manufacturing sector: a dynamic panel data analysis. Working Paper No. ­2013-02-01, Indian Institute of Management, Ahmedabad. Bhargava, A., & Sargan, J. D. (1983). Estimating dynamic random effects models from panel data covering short time periods. Econometrica: Journal of the Econometric Society, 51(6), 1635–1659. Bistrova, J., Lace, N., & Peleckienė, V. (2011). The influence of capital structure on Baltic corporate performance. Journal of Business Economics and Management, 12(4), 655–669. Bokhari, H. W., & Khan, M. A. (2013). The impact of capital structure on firm’s performance (A case of non-financial sector of Pakistan). European Journal of Business and Management, 5(31), 111–137. Brendea, G. (2014). Ownership structure, performance and capital structure of Romanian firms. Internal Auditing and Risk Management, 36(1), 1–9. Breusch, T. S., & Pagan, A. R. (1980). The Lagrange multiplier test and its applications to model specification in econometrics. The Review of Economic Studies, 47(1), 239–253. Bruton, G. D., Filatotchev, I., Chahine, S., & Wright, M. (2010). Governance, ownership structure, and performance of IPO firms: the impact of different types of private equity investors and institutional environments. Strategic Management Journal, 31(5), 491–509. Chamberlain, G. (1984). Panel data. Handbook of Econometrics, 2, 1247–1318. Cubbin, J., & Leech, D. (1983). The effect of shareholding dispersion on the degree of control in British companies: theory and measurement. The Economic Journal, 93(370), 351–369. Demsetz, H., & Lehn, K. (1985). The structure of corporate ownership: causes and consequences. Journal of Political Economy, 93(6), 1155–1177. Demsetz, H., & Villalonga, B. (2001). Ownership structure and corporate performance. Journal of Corporate Finance, 7(3), 209–233. Farooque, O. A., van Zijl, T., Dunstan, K., & Karim, A. W. (2007). Ownership structure and corporate performance: evidence from Bangladesh. Asia-Pacific Journal of Accounting and Economics, 14(2), 127–149.

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102  Capital structure, equity ownership and corporate performance Perrini, F., Rossi, G., & Rovetta, B. (2008). Does ownership structure affect performance? Evidence from the Italian market. Corporate Governance: An International Review, 16(4), 312–325. Pouraghajan, A., Malekian, E., Emamgholipour, M., Lotfollahpour, V., & Bagheri, M. M. (2012). The relationship between capital structure and firm performance evaluation measures: evidence from the Tehran Stock Exchange. International Journal of Business and Commerce, 1(9), 166–181. Saleem, Q., & Rehman, R. U. (2011). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), 95–98. Santos, M. S., Moreira, A. C. & Vieira, E. S. (2014). Ownership concentration, contestability, family firms, and capital structure. Journal of Management & Governance, 18(4), 1063–1107. Sargan, J. D. (1958). The estimation of economic relationships using instrumental variables. Econometrica: Journal of the Econometric Society, 26(3), 393–415. Selarka, E. (2005). Ownership concentration and firm value: a study from the Indian corporate sector. Emerging Markets Finance and Trade, 41(6), 83–108. Stiglbauer, M. (2011). Impact of capital and ownership structure on corporate governance and performance: evidence from an insider system. Problem and Perspective in Management, 9(1), 16–23. Stulz, R. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics, 26(1), 3–27. Ting, H. I. (2013). The influence of insiders and institutional investors on firm performance. Review of Pacific Basin Financial Markets and Policies, 16(4), 1350027. Vintila, G., Gherghina, S. C., & Nedelescu, M. (2014). The effects of ownership concentration and origin on listed firms’ value: empirical evidence from Romania. Romanian Journal of Economic Forecasting, 17(3), 51–71. White, H. (1980). A heteroskedasticity consistent covariance matrix estimator and a direct test of heteroscedasticity. Econometrica, 48(4), 817–818. Wintoki, M. B., Linck, J. S., & Netter, J. M. (2012). Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics, 105(3), 581–606. Wooldridge, J. M. (2009). Introductory econometrics: a modern approach, 4th edition. Mason: South-Western Cengage Learning. Zeitun, R. (2009). Ownership structure, corporate performance and failure: evidence from panel data of emerging market the case of Jordan. Corporate Ownership and Control, 6(4), 96–114. Zeitun, R., & Tian, G. G. (2007). Capital structure and corporate performance: evidence from Jordan. Australasian Accounting, Business and Finance Journal, 1(4), 40–61.

6

Ownership concentration and corporate performance An empirical inquiry

Introduction From the theories and empirical researches on ownership structure, it can be well understood that besides various forms of ownership like promoters’ ownership and institutional ownership, concentration or dispersion is a crucial aspect of the ownership of any publicly held company. We have already discussed in Chapter 4 about how ownership concentration can moderate the principal-agent agency relationship in an organization of separated ownership and control. We have also discussed with literature support how ownership concentration can mitigate this (type I or vertical) agency problem and contribute to better firm performance. Moreover, we have also seen the possibility of exploitation of the minority shareholders by the majority shareholders and the resultant underperformance by firms. Now, in this chapter, we have made an attempt to empirically test the theoretical and previously researched understandings on the relationship between ownership concentration and corporate performance in the context of the Indian manufacturing sector. The empirical analysis includes static and the generalized method of moments (GMM)-based dynamic panel data regression estimations. We have already given a detailed description of the methodology including statistical and econometric tools used in Chapter 5. The variable used to present ownership concentration is also introduced in the same chapter of the book. However, in this chapter, we are introducing another variable of ownership concentration, i.e. the largest ownership. This variable is introduced for the purpose of addressing a very important aspect, i.e. the special importance of the largest owners in Indian traditionally family-controlled manufacturing firms. Notably, the results of panel data estimations for all the variables taken together are shown in the last chapter. However, the panel data estimation relating to the newly introduced variable is shown in this chapter. Let us now go to the empirical findings on the relationship between ownership concentration and corporate performance. Ownership concentration and corporate performance: empirical findings The mean value of ownership concentration measured by using the HerfindahlHirschman index (HHI) is 0.15, which indicates a moderate level of ownership concentration. However, we find a standard deviation of 0.13 and the maximum DOI: 10.4324/9781003397878-6

104  Ownership concentration and corporate performance value of 0.55, which indicates that the level of concentration varies highly across firms (see Table 5.2). The panel estimation presented in the preceding chapter suggests an almost insignificant relationship between ownership concentration measured by the (HHI) and corporate performance (Tables 5.5, 5.7, 5.8, 5.10, 5.11, 5.13, 5.14, 5.16). Only the coefficient against return on equity (ROE) under the fixed effect model (FEM) is found to be statistically significant and positive with a low level of significance. Thus, the statistical relationship between ownership concentration and corporate performance is not found to be so strong. However, the relationship can’t be completely overlooked and we will explore the significance of concentration further through the introduction of the Largest Ownership variable. Largest ownership and corporate performance Considering the unique importance of largest shareholders especially in Indian manufacturing companies, the study attempts to estimate the effect of the largest shareholders’ ownership on the measures of corporate performance. Moreover, the study also estimates the non-linear relationship between the largest ownership and corporate performance in the context of Indian manufacturing companies. The non-linear effect and the threshold point of the largest ownership at which the effect changes are estimated and presented in this chapter. Largest ownership and its non-linear effect

This subsection is included as an extended part of data analysis considering a flurry of literature that suggests a non-linear relationship especially between ownership concentration and firm value in the context of various markets. Where in case of composition of ownership the evidence of non-linearity in relationship is very limited (e.g. Kumar, 2004), the studies on ownership concentration from different countries’ perspective as outlined in our review of literature section give evidence of linear as well as non-linear relationship. In this premise, authors find it more sensible to assume and test the non-linear relationship between the variables. Another notable fact is that where most of the manufacturing firms in India are familycontrolled (Selarka, 2005) the largest owner plays the most dominant role in the management of affairs of companies. In this study, among 86 manufacturing firms as the sample, average shareholding by the largest shareholder is 34.69 whereas largest value of the variable is found to be 98.38 percent. Therefore, recognizing the distinct importance of the largest shareholder in the Indian manufacturing sector, in this extended analysis the study makes an attempt to test the impact of largest shareholders on the performance of Indian manufacturing firms. To test the non-linearity the study again adopts the Arellano and Bond (1991) dynamic panel model, which is based on the GMM). In Table 6.1, the study in a very precise form presents the results of one-step estimation of dynamic panel data analysis of only the largest ownership variable denoted by Largest_Own. The authors consider the coefficients of one-step

Ownership concentration and corporate performance  105 Table 6.1 Test of Non-Linearity: Result of One-Step Estimation Variables

Largest_Own Largest_Own2 Wald–Chi2 Arellano-Bond Test for AR (1) Arellano-Bond Test for AR (2) Threshold (β1/2β2)

ROE

TQ

MBVR

Coefficient z-Stat

Coefficient z-Stat

Coefficient z-Stat

–0.380 –1.89* 0.004 1.71* 55.53*** –2.43** (p = 0.0151)

–0.058 –2.33** 0.0008 2.54** 41.35*** –4.74*** (p= 0.0000)

–0.166 –3.22*** 0.0017 3.03*** 33.54*** –4.43*** (p= 0.0000)

–1.64 (p=0.1006)

–1.50 (p= 0.1332)

36.25

48.82

0.05 (p = 0.9577) 47.50

Source: Calculated by the researcher. Notes i. *** Denotes 1 percent level of significance; ** denotes 5 percent level of significance; * denotes 10 percent level of significance. ii. z-Statistics in one-step estimation are based on robust standard error to control for heteroskedasticity and autocorrelation.

estimations to arrive at the findings as per the earlier given justification. The onestep estimators under dynamic panel data analysis report a non-linear effect of ownership by the largest shareholders on the accounting performance measured by ROE and market performance measured by Tobin’s Q (TQ) and market to book value ratio (MBVR) of Indian manufacturing companies. For all these three measures of financial performance, the study evidences a negative impact of largest ownership till a certain threshold of concentration and a positive impact thereafter. However, the study doesn’t find any significant non-linear relationship between largest shareholder’s ownership and ROA. Determination of threshold level of largest ownership

The study shows the quadratic relationship by estimating a non-linear model with a squared term of the independent variable. The quadratic curb has only one breakpoint, which is optimally derived by taking the first differentiation with respect to ownership concentration. The regression equation representing the quadratic relationship between the variables is as below: Yi = a + b1Xi + b 2 Xi 2 + ................ Now, as per the condition of maximum threshold, i.e. partial derivative should be equal to zero, the threshold level of Largest_Own can be derived by the following model: β1 + 2β2 Threshold of Largest_Own = 0, where β1 and β2 are the two coefficients of the variable and carry the opposite sign. or, Threshold of Largest_Own = –(β1/2β2)

106  Ownership concentration and corporate performance Following the technique, the thresholds of Largest_Own are found to be 47.50, 36.25 and 48.82 percent for ROE, TQ and MBVR respectively (Table 6.1). Discussion of results In the extended part of our panel data analysis, the study estimates a test for the non-linear effect of ownership concentration especially the ownership by the largest shareholder on firm performance. The non-linearity test is encouraged by a number of past empirical investigations like Caixe and Krauter (2013) in the context of Brazilian firms, Kumar and Singh (2013) in the context of BSE (Bombay Stock Exchange) listed Indian companies, Altaf and Shah (2018) in the context of Indian manufacturing companies. These studies documented either a U-shaped or an inverted U-shaped relationship between these two variables. The present study applies dynamic panel estimation to confirm the non-linear effect of ownership concentration by the largest shareholder on the financial performance of Indian listed manufacturing companies. Now, a negative impact which may be due to misaligned interest and expropriation effect by the largest shareholder is evidenced in Indian manufacturing firms which last up to a threshold of around 47.5 percent for ROE, 36 percent for TQ, 49 percent for MBVR (Table 6.1). The findings on the non-linearity effect on these three measures of firm performance are graphically presented in Figures 6.1–6.3. Therefore, we can infer that to ensure a favourable impact on both the measures of corporate performance the ownership by largest shareholder should approach around 48 percent. Thus, by and large this is a point where both the measures of financial performance, i.e. the market performance and the accounting performance especially the return in relation to equity investment of the Indian manufacturing companies, are showing a positive move. Though, at a threshold of around 36 percent the effect of largest ownership on market performance measures like TQ ROE

47.50 Percent

Figure 6.1  Non-linear Effect of Largest_Own on ROE Source: Authors

Largest_Own

Ownership concentration and corporate performance  107 TQ

36.25 Percent

Largest_Own

Figure 6.2  Non-linear Effect of Largest_Own on TQ Source: Authors MBVR

48.82 Percent

Largest_Own

Figure 6.3  Non-linear Effect of Largest_Own on MBVR Source: Authors

is found to be shifted from negative to positive, to have an assured effect we better set a target of 48 percent. Concluding remarks Based on the results obtained from this chapter and the last one (Chapter 5) regarding the ownership-performance relationship, the study fails to accept the null hypotheses of our hypotheses II and III. Therefore, the null hypothesis that says ‘there is no relationship between the ownership structure and corporate performance’ is not found to be valid for this study. Besides, the null hypothesis ‘ownership concentration does not significantly affect corporate performance’ is also rejected by the researchers.

108  Ownership concentration and corporate performance Having rejected the above two null hypotheses, the study confirms a statistically significant relationship between various forms of ownership including ownership concentration and the financial performance of manufacturing companies in India. References Altaf, N., & Shah, F. A. (2018). Ownership concentration and firm performance in Indian firms: does investor protection quality matter? Journal of Indian Business Research, 10(1), 33–52. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. Caixe, D. F., & Krauter, E. (2013). The influence of the ownership and control structure on corporate market value in Brazil. Revista Contabilidade & Finanças, 24(62), 142–153. Kumar, J. (2004). Does ownership structure influence firm value? Evidence from India. The Journal of Entrepreneurial Finance and Business Ventures, 9(2), 61–93. Kumar, N., & Singh, J. P. (2013). Effect of board size and promoter ownership on firm value: some empirical findings from India. Corporate Governance: The International Journal of Business in Society, 13(1), 88–98. Selarka, E. (2005). Ownership concentration and firm value: A study from the Indian corporate sector. Emerging Markets Finance and Trade, 41(6), 83–108.

7

Conclusion and policy recommendations

Introduction This chapter presents an overall summary of this empirical investigation including the concluding remarks. The chapter also provides the important suggestions and recommendations, each of which is very useful as a crucial piece of information for business entrepreneurs, corporate policymakers, corporate managers and business analysts. The chapter ends with a description about the limitations of the present empirical investigation along with directions for further researches into the concerned area. Summary of the study The various issues and aspects associated with the financing decision of a company like any other decision area are certainty crucial and complex. Equity shares are the owners’ funds whereas debt is the creditors’ funds and designing a judicious mix of these two sources of capital would likely promote administration, sound management and thereby superior firm performance. The relationship is theoretically well accepted and empirically established. Again, ownership structure, i.e. the pattern of distribution of equity ownership to different types of investors, is supposed to have important bearings on the financial success or failure of an enterprise. This is because equity investors are different in terms of objective of investment, expertise on investment nurturing and voting rights or control towards the action and decisions of management. It is true that an individual investor with a very small fraction of ownership in a firm along with less expertise would have more or less no influence on the decisions and functioning of the firm. On the other hand, large promoters and institutions having substantial ownership in the same firm with high expertise and specialized skill in nurturing investment and managing portfolios are expected to influence the firms’ performance and efficiency by participating in the crucial decisions and ensuring well-directed functioning of the firm accordingly. Moreover, in India where family-owned and inherited businesses form a major segment of the corporate sector, the role and influence of large shareholders and giant promoters are of special importance and are therefore research worthy.

DOI: 10.4324/9781003397878-7

110  Conclusion and policy recommendations Against this backdrop, the present study attempts to extend the existing set of literature by providing some empirical insights into the impact of capital and ownership structure on the accounting and market performance of Indian manufacturing companies. A strongly balanced panel data consisting of 86 manufacturing companies listed and traded in the BSE 200 index of the Bombay Stock Exchange of India is taken as the sample. To arrive at the results, the study adopts panel data regression analysis. Again, considering the dynamism of relationship and endogeneity problem, the study further adopts the Arellano and Bond (1991) dynamic panel model, which is based on the generalized method of moments (GMM), to arrive at robust results. Besides, guided by previous literature, the study also extends its analysis to check the non-linear effect especially of ownership concentration by the largest shareholder on the performance of Indian manufacturing firms. Based on panel data regression analysis (including dynamic panel estimation) the study finds capital structure to be negatively related to the accounting and market performance of Indian manufacturing companies. Therefore, the postulation of agency theory of Jensen and Meckling (1976) that increased debt acts as an internal instrument to discipline management and regulates managerial opportunistic behaviour, which leads to increased firm performance, does not seem to be operational in the Indian manufacturing sector. Rather, the findings of this study support the view of Myers (1977), which disapproves of the view of Jensen and Meckling (1976) and considers high debt as a potential source of conflict of interest between equity and debt holders as a result of default risk which brings another agency cost. According to him, it creates a problem called ‘underinvestment’ or ‘debt overhang problem’. Therefore, debt may create over-restrictions on investments and may ultimately unfavourably affect firm performance. The findings of the present study also endorse the previously documented evidence produced by Stulz, (1990), Krishnan and Moyer (1997), Kalcheva and Lins (2007), Dawar (2014), Pandey and Sahu (2019b), etc., and reinforce the view that a threat of liquidation is generated in firms due to high debt capital and its fixed payment obligations, which ultimately discourage managers to take risky projects even though they may have earning potential. This under-utilization of funds arising out of fear of losses leads to lowering the financial performance of the Indian manufacturing sector. The study confirms a significant and positive statistical relationship between domestic promoters’ ownership and the market-related performance of the sampled companies. However, the study does not evidence any significant statistical association between ownership by domestic promoters and accounting performance of Indian manufacturing companies. By and large, the impact of domestic promoters on the financial performance of Indian manufacturing companies is not found to be so strong and thus the monitoring efforts as supposed to be undertaken by them seems to be marginal. The results therefore signify the need of Indian promoters to be vigilant and more serious about their role in monitoring and supervising management with the objective to resist opportunistic use of corporate resources and curtail type I or vertical agency problem. However, the shareholding by the foreign promoters is found to positively influence the accounting as well as the market performance of Indian manufacturing firms. Therefore, our study in this regard goes in

Conclusion and policy recommendations  111 line with the findings of Pant and Pattanayak (2007), Manna et al. (2016), Mishra and Kapil (2017), which also endorse the positive impact of promoter ownership in general on firm performance. So far as the findings regarding institutional ownership and firm performance are concerned, the study documents a significantly positive impact of institutional ownership on all the variables used to measure the accounting and market performance of the sampled firms for both the estimation techniques. In this regard, the study endorses the efficient monitoring hypothesis among the three hypotheses developed by Pound (1988). Therefore, in line with this hypothesis, our study sees institutional shareholders in India as investment experts, efficient monitors and active participant in business affairs. The study recognizes their professional expertise, monitoring efficiency and investment nurturing capability. Institutional ownership is also proven to be complementary to the internal governance mechanism of Indian manufacturing companies. Finally, the findings of the present study relating to the effect of institutional investors’ shareholding and firm performance are aligned with the studies of McConnell and Servaes (1990), Douma et al. (2006), Sahut and Gharbi (2010), Striewe et al. (2013), etc. Coming to the context of ownership concentration, the study doesn’t report any such significant impact of ownership concentration in the financial performance of Indian manufacturing firms. Only a very feeble but positive relation is found with one of the accounting measures of performance. However, taking the 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 financial performance of such firms. The thresholds are estimated to be around 48 percent for return on equity, 36 percent for Tobin’s Q and 49 percent for market to book value ratio, 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 at least around 36 percent, before which the expropriation effect becomes prominent due to misaligned interests with the firm. However, ownership concentration shows a positive effect on both the measures of financial performance of our study only when it touches a threshold of around 48 percent. Therefore, a threshold of around 48 percent for the largest owner’s shareholding may be considered to be more desirable in the case of manufacturing companies in India. This finding can be aligned with the study findings of Kumar and Singh (2013), who establish a threshold of 40 percent of ownership for large promoters of Indian firms for aligning their interests with the firms. Moreover, in line with Altaf and Shah (2018), the findings of the present study also indicate expropriation and exploitation of minority shareholders by the majority shareholders (the largest ones) in Indian manufacturing firms. Although the expropriation effect is evidenced up to a certain threshold of ownership concentration but the opportunistic behaviour and exploitation of majority owners and largest owner cannot be completely denied in case of the manufacturing sector in India. In other words, it is a matter of concern for corporate stakeholders especially the minority shareholders that the expropriation effect co-exists with the monitoring effect in the Indian manufacturing sector.

112  Conclusion and policy recommendations Inquiring into the root causes behind such expropriation in Indian firms we reach some specific reasons as to why it is quite easy to abuse minority shareholders in India. First, the status of minority shareholders in India is largely different in comparison to the developed economies’ markets like the U.S. and the U.K. For instance, in the U.S. all major corporate decisions are initiated by the board itself and the majority shareholders hardly influence any such corporate decisions of the board. The shareholders may change the course of the corporation only by replacing the board. Conversely, in India, a board follows the fundamental principle while taking the corporate decisions that the opinion of the majority shall always prevail. Second, both the versions of the Indian Companies Act, i.e. of 1956 and of 2013, have prescribed more or less similar criteria for minority shareholders to apply to the National Company Law Tribunal or previously Company Law Board in case they feel oppressed. As per the provision of the Companies Act, a member/ shareholder having less than 10 percent of ownership in companies issued share capital can’t alone seek redressal from the tribunal in case he/she feels oppressed. In such case, a minimum of 100 members or 1/10th of total members whichever is lower is required to be applied to the tribunal. More often than not, it becomes cumbersome work for minority shareholders in India especially with less financial awareness and knowledge of legislation to comply with above-stipulated criteria. Third, the tribunal also shows reluctance to quickly interfere in internal corporate affairs with the caution that there may be unscrupulous shareholders who can take undue advantage of the provisions by acting in the pretext of investors’ rights. Apart from these, there are a number of instances when courts in India, which act on the principle of non-interference, had refused to interfere in the management of a company. Finally, high cost, tedious & vexing legal procedures, less hope & instances of success and lack of financial education & legal awareness have also discouraged ordinary investors of India to initiate action against giant shareholders who are economically and politically very powerful. Thus, the provisions on minority interest protection in India seem quite inaccessible and unrealistic for the common investor and it becomes quite easy for majority shareholders to reap the benefit of the legal flows or regulatory loopholes. However, it is indeed a good sign that after a certain threshold a favourable impact is found to be exerted by the largest shareholder on the financial performance of the sampled companies. Therefore, ownership concentration by largest owner at a high level is becoming a complementary force with the external institutional specifications and is acting as an internal regulatory mechanism to dismantle the type I agency problem and improve firm performance. Conclusion The study finds capital structure and the various forms of ownership highly relevant and crucial towards the governance and performance of Indian manufacturing companies. The capital structure of Indian manufacturing companies is found to be very relevant to the accounting performance and shareholders’ value creation. Interestingly, the postulation of agency theory, propounded long before in the

Conclusion and policy recommendations  113 pioneering study of Jensen and Meckling (1976), that increased amount of debt can act as a disciplinary force to restrain managerial opportunism is not found to be true in the case of Indian manufacturing companies. Rather, we see the opposite evidence that higher the degree of leverage lower is the financial performance. Besides, like capital structure, the ownership structure and its concentration are also found to be very much significant for the corporate governance and performance of Indian manufacturing companies. Regarding the ownership-performance relationship, the institutional type of ownership is seen to be the common influencing factor for all the measures of accounting and market-related performance. Besides ownership concentration as a whole, the largest shareholder is also found to have a crucial bearing on the governance and performance of Indian manufacturing companies. Especially in case of the largest shareholder, the study finds interesting evidence. The largest shareholders are found to exert a two-fold impact on the internal governance of Indian manufacturing companies. At the lower level of concentration, they are found to pursue an expropriating role whereas after a certain threshold their role within the businesses gets shifted to active monitoring. This may be due to the fact that the interest of largest owners is initially misaligned with the interest of the shareholders fraternity as a whole but after a certain threshold of ownership the misalignment of interest is restored, the expropriation effect disappears and active monitoring effect begins to play a role. Finally, it can be concluded that corporate entrepreneurs of the Indian manufacturing sector who hold good grief over capital and equity ownership structures are highly supposed to ensure a vibrant internal governance mechanism and effective regulatory framework. This ultimately provides them a competitive advantage in terms of low agency problems, minimized internal conflicts, high operational efficiency and improved firm performance and market valuation. Recommendations and policy implications The study, in the context of Indian manufacturing firms, sharply questions the postulation that the use of debt capital can discipline managerial discretions and align owner-managers’ interests. The unfavourable impact of debt on agency cost and performance clearly points towards the need for alternative disciplinary mechanisms (internal or external) to address this crisis. As a part of internal governance, institutional owners along with large block holders can be an effective tool for ensuring efficient monitoring of management in such firms. Besides, stricter external regulatory specificities are also recommended as a complementary mechanism to the internal regulatory mechanism. The study finds an expropriation effect along with better monitoring by the largest shareholder. Thus, the study based on its findings cannot completely rely on the role of ownership concentration especially of majority shareholders as an internal governance mechanism in the Indian manufacturing firms and accordingly suggests stricter external regulatory and institutional specificities as an alternative mechanism that could ensure better corporate governance and protection of minority shareholders interest as previously suggested by Kumar and Singh (2013),

114  Conclusion and policy recommendations Hamid et al. (2016), Altaf and Shah (2018). The study also recommends possible amendments in the corporate laws towards improving the legal status and redressal seeking power of the small investors in India. In a nutshell, the study bears an important message for the Indian manufacturing firms that they should be much more reliant on efficient ownership structuring and external regulatory establishments rather than debt financing for the purpose of disciplining managerial opportunistic behaviour, regulating agency cost and ensuring improved corporate performance. Contribution of the study The output of this empirical research is highly expected to add incremental value in the domain of corporate finance and governance. The study successfully produces some fresh empirical insights relating to the effect of capital structure and ownership structure on the performance of manufacturing companies in the context of India. The various findings of this research, especially the evidence of the twofold effect of largest shareholder on the corporate governance and performance of Indian manufacturing companies, are supposed to have crucial importance for scholars and academicians belonging to this domain of knowledge and for corporate policymakers of the manufacturing sector in India. The researcher also expects this study to further broaden the existing set of knowledge about this subject among the students of finance and economics, researchers in the domain of corporate governance and financial management and other concerned individuals. Scope for future research We must admit that the findings and thereby drawn inferences of this study are valid for Indian manufacturing companies. Besides, the findings, interferences and policy recommendations of the study are based on the concurrent political, economic & legal framework of India. Therefore, the validity of the study may be lost with the changing economic, political and legal environment of varied time periods. Hence, further studies on other sectors, markets or for different time periods may reveal varied results. Moreover, the study strongly recommends sectorspecific inquiries and even cross-country investigations as future research avenues. References Altaf, N., & Shah, F. A. (2018). Ownership concentration and firm performance in Indian firms: does investor protection quality matter? Journal of Indian Business Research, 10(1), 33–52. Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297. Dawar, V. (2014). Agency theory, capital structure and firm performance: some Indian evidence. ­ Managerial Finance, 40(12), 1190–1206.

Conclusion and policy recommendations  115 Douma, S., George, R., & Kabir, R. (2006). Foreign and domestic ownership, business groups, and firm performance: evidence from a large emerging market. Strategic ­Management Journal, 27(7), 637–657. Hamid, M. A., Ting, I. W. K., & Kweh, Q. L. (2016). The relationship between corporate governance and expropriation of minority shareholders’ interests. Procedia Economics and Finance, 35, 99–106. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior; agency costs and capital structure. Journal of Financial Economics, 3(4), 305–360. Kalcheva, I., & Lins, K. V. (2007). International evidence on cash holdings and expected managerial agency problems. Review of Financial Studies, 20(4), 1087–1112. Krishnan, V. S., & Moyer, R. C. (1997). Performance, capital structure and home country: an analysis of Asian corporations. Global Finance Journal, 8(1), 129–143. Kumar, N., & Singh, J. P. (2013). Effect of board size and promoter ownership on firm value: some empirical findings from India. Corporate Governance: The International Journal of Business in Society, 13(1), 88–98. Manna, A., Sahu, T. N., & Gupta, A. (2016). Impact of ownership structure and board composition on corporate performance in Indian companies. Indian Journal of Corporate Governance, 9(1), 44–66. McConnell, J. J., & Servaes, H. (1990). Additional evidence on equity ownership and corporate value. Journal of Financial Economics, 27(2), 595–612. Mishra, R., & Kapil, S. (2017). Effect of ownership structure and board structure on firm value: evidence from India. Corporate Governance: The International Journal of Business in Society, 17(4), 700–726. Myers, S. C. (1977). The determinants of corporate borrowings. Journal of Financial ­Economics, 5(2), 147–175. Pandey, K. D., & Sahu, T. N. (2019). Debt financing, agency cost and firm performance: evidence from India. Vision, 23(2), 267–274. Pant, M., & Pattanayak, M. (2007). Insider ownership and firm value: evidence from Indian corporate sector. Economic and Political Weekly, 42(16), 1459–1467. Pound, J. (1988). Proxy contests and the efficiency of shareholder oversight. Journal of Financial Economics, 20, 237–265. Sahut, J. M., & Gharbi, H. O. (2010). Institutional investors’ typology and firm performance: the case of French firms. International Journal of Business, 15(1), 33–49. Striewe, N., Rottke, N., & Zietz, J. (2013). The impact of institutional ownership on REIT performance. Journal of Real Estate Portfolio Management, 19(1), 17–30. Stulz, R. (1990). Managerial discretion and optimal financing policies. Journal of Financial Economics, 26(1), 3–27.

Index

bank 43

net income approach 10 net operating income approach 12 net worth 19 non-banking financial institutions 45 non-financial performance 18

capital budgeting 1 capital structure 2 conflict of interest hypothesis 46

optimum capital structure 3 ownership concentration 62 ownership structure 40

debt overhang problem 21, 110 descriptive statistics 87, 88 dispersed shareholding 62 dynamic panel data analysis 86, 88

panel data 84 pecking order theory 15 performance 17 performance measurement 17 portfolio 44 price earning ratio 20 profit margin 19 promoter 40, 41

agency cost theory 21 arbitrage 14 assets utilization efficiency 80

economic value added 20 efficient monitoring hypothesis 3, 46, 63 expropriation hypothesis 63 financial distress 15 financial performance 18, 19 financing decision 1, 2, 4 heteroskedasticity 83, 84 horizontal agency problem 4, 63 institutional investors 4, 40, 42, 79 insurance companies 45 interest tax shield 2 market timing theory 16 market to book value ratio 20 market value added 20 Modigliani-Miller hypothesis 13 multicollinearity 82 mutual fund 44

return on assets 19 return on capital employed 19 return on equity 19 return on net worth 19 static panel data analysis 84 strategic performance 18 strategic-alignment hypothesis 46 Tobin’s Q 20 trade-off theory 15 traditional approach 2, 14 underinvestment 21 variance inflation factor 83 vertical agency problem 16, 17