Impact of Corporate Governance Mechanisms on the …Mahmoud Moeinadin Department of Accounting, Yazd Branch, Islamic Azad University, Yazd, Iran ... Samaha et al (2012) argues that

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

COPY RIGHT © 2013 Institute of Interdisciplinary Business Research 449

NOVEMBER 2013

VOL 5, NO 7

Impact of Corporate Governance Mechanisms on the Financial Decisions and Cost

of Equity of the Firms Listed on the Tehran Stock Exchange

Mahmoud Moeinadin

Department of Accounting, Yazd Branch, Islamic Azad University, Yazd, Iran

Safaieeh, Shohadegomnam Road, Zip code: 89195/155, Yazd, Iran

(Corresponding author)

HasanDehghanDehnavi

Department of Management, Yazd Branch, Islamic Azad University, Yazd, Iran


MirzaHoseinMirbafghi

Department of Accounting, Yazd Branch, Islamic Azad University, Yazd, Iran


The Author to whom we should address our correspondence: MahmoudMoeinadin, Assistant Professor of

Accounting, Department of Accounting, Yazd Branch, Islamic Azad University, Yazd, IRAN.

A contact address, telephone/fax numbers and e-mail address: Shohadaegomnam Road, Safaieeh, Zip code:

89195/155

Abstract

Capital structure decisions are one of the fields in which the impact of corporate governance on the decision

making process might be examined. This topic has been less considered in the prior studies. The present paper aims

to provide evidence about this topic. Using a sample composed of 94 listed firms on the Tehran Stock Exchange

and a set of data during 2007-2011 and using structural equation modeling, the research hypotheses have been

tested. The findings revealed that:

There is a positive significant association between corporate governance and dividend policy.

There is a negative association between the corporate governance and long-term debts to the assets ratio.

There is a positive and significant association between the corporate governance and long-term debts to

the assets ratio. In addition, it is found that the corporate governance and the ratio of total debts to the

assets are significantly associated.

In terms of the effect of the corporate governance variables on the cost of capital of the Tehran listed

firms, it is found that there is a significant negative relationship between the corporate governance

variables and cost of debts, cost of owners’ equity and the weighted average of the cost of equity.

The other findings reveal that the CEO influence is the most important factor in this system and the ratio of long-

term debts on the assets and the cost of the owner’s equity are the most significant indexes of capital structure and

cost of equity.

Keywords: Corporate Governance, Finance Decisions, Cost of Equity, Institutional Investors, Non-executive

Board Members, Board Size.

1. Introduction

Having a regular and established plan called corporate governance is one of the factors by which the corporations

are able to utilize the globalization benefits and supply their stocks in the verified stock exchanges around the

world. By doing so, the long-term and low cost equities might be attracted. Following the appropriate principles

and methods of corporate governance increase the confidence in the investors and reduces the cost of equity and

reinforces the capital markets (Classness, 2002).

Samaha et al (2012) argues that corporate governance increases the confidence in the national economy and

strengthens the capital market. In addition, this system leads to increasing the investment amount, the protection of

the minority shareholders and motivates the private department so that the competitive advantages are protected

and the projects are financed and provide job opportunities.

Corporate governance includes different types of organizational mechanisms and the balance trends in the power

hierarchy and the responsibility of the shareholders, managers, board of directors and employees (Lin and Liu,

2009). Ownership structure, board size, the board independence and CEO duality are the most important factors

affecting the corporate governance. Bloomefiled (2004) believes that one of the most significant benefits of the

corporate governance establishment makes the companies capable of increasing their capital by the lower cost of

equity.

Based on the literature review of agency theory, using more debts in the capital structure is a way to reduce the

need to finance through owners’ equity and mitigate the conflict of interests among the directors and shareholders.

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According to the modern finance literature, the agency conflict is a determinant in determining the capital structure

decisions. In addition, the financial decisions are the strategic decisions in managing the company's affairs and are

affected by the governance mechanisms (Setayesh et al, 2011).

On the other hand, Lambert (2006) developed a theoretical framework linking the quality of the accounting

information system to the cost of equity. Accounting information quality does not include the disclosures to the

outsiders, but it involves the internal control system and corporate governance principles within an organization.

The findings indicate that the quality of the accounting information has direct and indirect impacts on the cost of

equity. The direct impact is due to the fact that the qualified information reduces the cost of equity by reducing the

covariance with the cash flows of the other companies. The indirect impact relates to the influence of the quality of

the corporate governance on the real decisions such as the resources allocated to the directors. Strong corporate

governance reduces the resource allocation to the directors and increases the future cash flows available for the

firm.

Lambert (2006) developed a model in relation to the expected costs of the agency relationship between the internal

and external stakeholders. In his model, the monitoring costs are incurred by the investors and are the functions of

the corporate governance quality. He argued that the investors demand lower cost of equity for the firms with

stronger corporate governance (Mohebbi, 2010).

Based on the above mentioned points, it can be found that the mitigation of the conflict of interest is related to the

finance through debts. Furthermore, finance decisions are associated with the agency costs and corporate

governance mechanisms. In the present study, the factors impacting the financial decisions and cost of equity of the

Tehran listed firms have been investigated in terms of the corporate governance.

The prior literature and research background have been also reviewed and the findings and suggestions are finally

provided.

2. Research Background and Literature Review

There are a variety of studies conducted about the quality of the corporate governance on the financial decisions

and cost of equity. Some studies confirm the positive association; while the others show the negative relationship

between the two variables.

Wen et al (2002) discovered the positive relationship between board size and capital structure. They found that the

larger board of directors tries to create higher debt levels to increase the firm value especially when the regulatory

authorities have high control over them.

Pittman and Fortin (2004) examined the influence of auditors’ reputation at the cost of debts. They found that those

companies using big auditing firms have lower cost of debts. Therefore, the audit quality is inversely related to the

cost of debts and the creditors’ risk.

The findings of Abor and Biekpe (2005) confirm the negative association between the board size and the financial

leverage. They also found that the larger board of directors is associated with the lower debt levels.

Abor (2007) indicated that those firms with higher leverage rates have more non-executive members of the board of

directors and the lower percentage of the non-executive members is followed by lower financial leverage.

To examine the impact of ownership structure and corporate governance on the capital structure of the Pakistani

firms, a study was conducted by Hasan and Butt (2009). The findings indicated that the board size and management

shareholding have negative correlations with the ratio of debts to the owners’ equity. However, the finance

behavior is not impacted by the membership of the CEO on the board of directors and the non-executive members

of the board. In addition, the findings confirm the positive and nonsignificant relationship between the institutional

ownership and capital structure.

Biekpe and Arko (2009) found that the shareholding of the management is significantly associated with the positive

impact on the selection of the long-term debts more than the owners’ equity. However, the ownership of the foreign

stocks on the prediction of the capital structure decision is insignificant. The board size has a positive and

significant relationship with the capital structure. On the other hand, the board independence and power

concentration are the significant factors in the selection of the financial components of the firms listed on the Ghana

Stock Exchange.

Ali Shah and Butt (2009) examined the effect of corporate governance mechanisms on the cost of equity of the

Pakistan listed firms. They documented a negative association between board and audit committee independence

and cost of equity and they also suggested that there is a positive relationship between the board and audit

committee independence and the cost of equity.

Kournaydi and Tourani Rad (2009) examined the impact of corporate governance mechanisms on the finance

methods and cost of equity. The findings showed that those firms with the least protection of the shareholders’

rights use more debts to finance. However, those firms which use better corporate governance mechanisms use

debts as the financial instruments and utilize dividends in their capital structure. The cost of equity of the firms with

satisfied corporate governance systems is lower than the firms with the unsatisfactory corporate governance

systems.

Parlack (2010) investigated the impact of size, risk, growth, tax rate and collateral value of the leverage ratio of 145

firms listed on the national Turkish Stock Exchange. The findings offered that the firms tend to use internal funds

to finance their operations. In addition, the common stocks are undervalued in the crisis period; the firms rely on

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the bank facilities regardless of the risk structure and size and this does not hold true for the economic development

situations. The firms with lower operational risk prefer short-term borrowings.

Laridi Su (2010) conducted a study about the relationship between ownership structure, firm diversity and capital

structure of the governmental firms listed on the Chinese Stock Exchange. These questions were examined: (1)

Howis the influence of diversified firms on the different capital structure decisions? (2) Does the ownership

structure depend on the identification of the different strategies and the selection of the financing choices.

The findings documented that the firm’s diversifying in the related and unrelated operations has an inverse

influence on the capital structure after controlling the ownership structure and corporate governance mechanisms. It

was also found that state owned firms use more debts in their financing decisions.

Wong et al (2011) examined the dividend policy on the Taiwan listed firms through testing the life cycle and they

found that the relationship between cash dividends, high profitable dividends, higher growth of assets, a higher

ratio of the market value of the book value is more significant than the time there is no cash dividend. This is

consistent with the life cycle of the dividends in the younger firms with higher growth potential. However, those

firms with lower profitability have a lower tendency to use cash dividends.

Ammann et al (2011) investigated 64 corporate governance characteristics in terms of six groups (board

responsibility, financial disclosure and internal control, shareholder’s rights, rewards, market control and firms’

behavior) among 22 developed firms during 2003 to 2007 and found that there is a positive significant relationship

between the corporate governance characteristics and firm value.

Chen and Chen (2012) tried to find whether the corporate governance mechanisms impact the inefficiency of the

capital allocation followed by the declining value of different firms.

Their findings showed that aligning the interests of the shareholders and directors in different firms leads to the

more efficient allocation of the capital among departments and the internal and external corporate governance

structures cause more effective investment decisions of the diversified firms.

Jiraporn et al (2012) explored whether the capital structure is impacted by the corporate governance quality. They

concluded that there is an inverse relationship between financial leverage and the quality of corporate governance.

That is, those firms with weak corporate governance have higher financial leverage.

3. Methodology

This is an applied study classified as a descriptive study concentrated on examining the relationship between the

variables. In addition, the covariance matrix is used along with the model of MIMIC.

3.1 Population, Sample Size and Sampling Method

The population includes the firms listed on the Tehran Stock Exchange during 2007 to 2011. The sample is

composed of 94 listed firms selected by filtering technique based on the three measures as follows:

1. The financial intermediaries and investment corporations have been excluded.

2. The financial year is consistent with the calendar year and there is no change in the fiscal year.

3. The detailed and complete information on the financial statements have been available.

Based on the theoretical concepts and the research backgrounds, some hypotheses are proposed. A complete model

of structural equation includes two elements: 1. The structural model and 2. The measurement model. Accordingly,

the hypotheses might be classified into two sections. The hypotheses based on the structural model and the

hypotheses based on the measurement model.

a) Hypotheses based on the structural model

H1. Corporate governance impacts the dividend policy.

H2. Corporate governance impacts the ratio of long-term debts to the assets.

H3. Corporate governance impacts the ratio of short-term debts to the assets.

H4: Corporate governance impacts the ratio of total debts to the assets.

H5: Corporate governance impacts the cost of capital.

H6: Corporate governance impacts the cost of the owners’ equity.

H7: Corporate governance impacts the weighted average of the cost of capital.

b) Hypotheses based on the measurement model

H1a. The percentage of the institutional investors, presence of the independent auditor, board size, CEO duality,

CEO influence, the ratio of non-executive members of the board, and the CEO consistency measure the concept of

corporate governance.

H2a. The ratio of dividend per share to the earnings per share measures the concept of dividend policy.

H3a. The ratio of long-term debts to the assets, the ratio of short-term debts to the assets and the ratio of total debts

to the assets measure the concept of capital structure.

The required data is gathered in different ways. The theoretical data such as the literature review is collected by the

library method and the variable data is collected from different information databases such as Tadbir Pardaz,

Rahavarde Novin and other bases verified by the Tehran Stock Exchange. To analyze the data, EXCEL and

LISREL have been applied.

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4. Variables

The research variables are as follows:

The ownership percentage of institutional investors: The emergence of the institutional investors as the owners of

the firms has been considered as one of the effective mechanisms of corporate governance. The institutional

investors own a large share of the stocks and are professional in the investment and have the power and ability to

monitor the companies. The definition of the Tehran Stock Exchange is used to calculate the institutional investors

including:

1. Banks and insurance companies, 2. Holdings, investment firms, pension funds, hedge funds, and the investment

funds registered with the Tehran Stock Exchange, 3. The owners who buy more than five percent or five billion

rials of the outstanding securities, 4.Public and governmental organizations, 5. State owned firms and the board

members and the individuals with the similar operations. The information of this variable is collected by the report

of the independent auditor and legal inspects.

4.1 The ratio of the non-executive members of the board:To control over the agency problem, the agency costs are

incurred to mitigate the conflict of interests among the owners and the agents. Employing the non-executive

(independent) members of the board of directors is one of the ways to control the agency issue. The non-executive

members are the professional directors aimed to control the decisions. They aim to resolve the agency problems

associated with the executive members and shareholders. In addition, the academic studies confirm that the non-

executive members better protect the benefits of the shareholders and are better proxies for them (Lem et al, 2007).

This ratio is calculated by dividing the number of the non-executive members to the total board members. Samaha

et al (2012) and Chahine and Filatotchev (2011) also used this ratio in their studies. The related information is

collected from the reports of the board of directors.

4.2 CEO Duality: The dual role of CEO gives more responsibility to the CEO and might mitigate the efficiency of

the monitoring role of the board of directors and the wastage of the stakeholders’ rights. Based on the prior studies,

separating the dual role makes the board more independent and reduces the agency problems and increases the

quality of the financial reporting (Maghari Zadeh et al, 2010). This variable is obtained from the reports of the

board of directors and those firms with the dual role of CEO are equal to one and zero, otherwise. Samaha et al

(2012), Mara et al (2011), Lin and Liu (2009) and Rudiger et al (2010) employed dummy variables to measure

CEO duality.

4.3 Board Size: The theoretical background provides two conflicting perspectives bout the role of board size. The

first one suggests that larger board increases the agency problem because a number of the board members might

operate as the useless individuals (Hermalin and Visbek, 2003). On the other hand, the second perspective offers

that the smaller board of directors is deprived of the advantages and benefits of the expert and diversified opinions

and suggestions of the larger boards. In addition, the larger board of directors is more advantageous in terms of the

experience, gender, nationality and others (Dalton and Dalton, 2005). All board members are considered to measure

the board size. Samaha et al (2012), Mara et al (2011) and Ali Shah and Butt (2009) employed all board members

to measure the board size.

4.4 CEO Influence: This variable considers the chief of the board of directors as a non-executive member. The

corporate governance regulators found that CEO, as a source of power, influences on the board of directors. The

chief of the board holds the responsibility to monitor the CEO. The difference between the advantages of the CEO

and the shareholders brings problems for the CEO influence (Aghayi et al, 2009). In this study, the firms in which

CEO is the executive member equal one and the others equal zero. Aghayi et al (2009) and Kamalian et al (2010)

employed the executive or non-executive members as the proxies of CEO influence. The related data has been

gathered from the reports of the board of directors.

4.5 Audit firm size (Independent auditor): The audit quality directly associated with the corporate governance and

monitoring mechanism has a hidden and multidimensional structure (Lin and Liu, 2009). Therefore, there is no

comprehensive definition developed for the audit quality which covers all types of auditing or auditors. In doing so,

some measures such as audit firm size, background and brand have been considered as substitutes for the audit

quality. A two dimensional classification has been used to divide the type of audit firms into two groups. These

groups include the audit organization as an indicator of quality and the other Iranian audit firms. This dummy

variable is gathered from the audit reports and it is equal to 1 for those companies audited by the audit organization

and the remaining companies are equal to zero. In a study conducted by Siregar and Utama (2008), it was found

that being audited by a big auditing firm is equal to 1 and zero, otherwise. The big audit firm is the same as the

audit organization in this study. To calculate the audit firm size, the reports of the independent auditor and legal

inspectors have been utilized.

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Table1.Summary of variables

calc

ula

tio

ns

So

urc

e

ab

bre

via

tio

n

Tit

le

No

.

The percentage of the shares owned by the

banks, insurance companies, pension

funds and investment holdings

.

Stock Exchange INSOWN

Theownership

percentage of

institutional investors

1

Equals one if the firms is audited by the

audit organization, and equals zero,

otherwise

Siregar and

Utama(2008) QAUDIT

Audit firm size

(presence of an

independent auditor)

2

Total board members

Samaha et al

(2012), Marra et al

(2011)

BRDSZE Board size 3

Equals one when the CEO is the chief

of the board and equals zero, otherwise

Marra et al (2011),

Lin and Liu (2009)

DUALITY CEO duality

4

Equals one when the chief of the board

is executed, and equals zero, otherwise.

Aghayi et al (2009),

Kamalian et al

(2009)

CEOD CEO influence

5

The ratio of non-executive members to

the total board members

Samaha et al

(2012), Chahine and

Filatotchev (2011)

NXRATIO

The ratio of non-

executive members of

the board

6

Equals one when there are changes of

CEO during the past two years and equals

zero, otherwise

Sasani and Safar

Zadeh (2011) CEOCON CEO Consistency 7

The ratio of short-term debts to the

assets and the ratio of long-term debts to

the assets and the ratio of total debts to the

total assets

Arbabiyan and

Safari Gerayeli

(2009)

STD/ASSETS LTD/ASSETS TD/ASSETS

Capital Structure 8

WACC =We. Ke + Wd. Kd Fahimi (2010) Kd, ke,WACC

Cost of debt, cost of

owner’s equity and the

weighted average of cost

of capital

9

Dividend per share to the earnings per

share

Setayeshand

KazemNezhad)2010) DIVPOL Dividend Policy 10

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5. Data analysis

The descriptive statistics are initially provided in this section and followed by analyses of the research hypotheses.

Table2. Descriptive statistics

Statistical Index Number Mean Median Std. Deviation

Skewness

coefficient

Kurtosis

coefficient Variable

INSOWN 470 77.42 81.63 16.11 1.20- 1.47

EAUDIT 470 0.27 0 0.44 1.05 0.90-

BRDSZE 470 5.06 5 0.39 2.39 1.11

DUALITY 470 0.02 0 0.14 7.04 4.76

CEOD 470 0.3 0 0.46 0.9 1.20-

NXRATIO 470 0.56 0.6 0.26 0.62- 0.17-

CEOCON 470 0.73 1 0.45 1.03- 0.95-

DIVPOL 470 0.71 0.77 0.75 5.52 4.83

STD/ASSETS 470 0.56 0.57 0.23 1.75 1.52

LTD/ASSETS 470 0.08 0.05 0.09 2.39 7.98

TD/ASSETS 470 0.64 0.65 0.23 1.91 1.41

Kd 470 0.09 0.09 0.05 3.2 3.03

Ke 470 0.24 0.16 0.55 4.3 5.51

WACC 470 0.18 0.14 0.3 3.83 3.91

Table 2 reveals the descriptive indexes. Due to the high coefficient of skewness and kurtosis of some variables, it is

found that the distribution of these variables is very different from normal distribution. Furthermore, the maximum

likelihood has been used to estimate the model parameters and it is based on the assumption that the variables are

normally distributed. The abnormal distribution of sample leads to a deviation from the ML method for estimating

the parameters of the structural equation modeling. Therefore, the variables are normalized before analyses and the

relationship between the observed variables are calculated by covariance matrix based on the normalized scores.

5.1 Goodness of Fit of the Model Estimation

Modeling aims to specify the determinants of the capital structure, cost of capital and corporate governance and it

also seeks to determine the causal relationship between the corporate governance, dividend policy, capital structure

and cost of equity. To make sure that the multivariate indexes-multiple factors might be used as a possible

description of the relationship between the tested variables, the goodness of fit indexes are calculated by LISREL

software and summarized in the following table.

Table3. Goodness indexes of the model

Degree of freedom 21

Chi squared of the minimum fitness function (07/0 =) P 21/23

Chi squared of the weighted squares of the normal theory (07/0 =) P 35/23

Root mean square error of approximation (RMSEA) 0/0

Normalized fitness index (NFI) 951/0

Non-normalized fitness index (NNFI) 02/1

Consistency fitness index (CFI) 00/1

Incremental fitness index (IFI) 02/1

Residuals of mean root (RMR) 03/0

Goodness of fit index (GFI) 00/1

Adjusted goodness of fit index (AGFI) 968/0

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Based on the above table, the model has a relative goodness of fit and it can be concluded that a model is developed

about the relationship between the variables under study.

5.2 Findings related to the hypotheses

Using t tests, the research hypotheses have been examined in terms of two groups of structural and measurement

classes.

Table 4. Findings of testing the structural hypothesis

Direct impact of variables Estimation value Standard error T value Sig. level

Effect of corporate governance on the dividend

policy 111/0 04/0

** 42/2 01/0> p

Effect of corporate governance on the ratio of

long-term debts to the assets 28/0- 05/0

** 17/5- 01/0> p


short-term debts to the assets 13/0 04/0

** 94/2 01/0> p


total debts to the assets 18/0 04/0

** 91/3 01/0> p

Effect of corporate governance on the cost of

debts 17/0- 05/0

** 01/3- 01/0> p

Effect of corporate governance on the cost of

owner’s equity 08/0- 04/0

* 81/1- 05/0> p

Effect of corporate governance on the weighted

average of cost of capital 08/0- 04/0

* 81/1- 05/0> p

Findings related to the hypotheses based on the structural modelBased on the above table, the direct relationship of

the corporate governance effect on the dividend policy is (γ-0.111, p<0.01) and the value of t shows that there is a

positive significant relationship between corporate governance and dividend policy. Consequently, the first

hypothesis is confirmed at 99 percent of significance. In terms of the effect of corporate governance on the ratio of

long-term debts to the assets, it can be concluded that (γ=0. 28, p<0.01) there is a significant negative relationship

between corporate governance and the ratio of long-term debts to the assets. Therefore, the second hypothesis about

the effect of corporate governance on the ratio of long-term debts to the assets is confirmed at 99 percent level of

significance.

The findings in table 5 about the direct relationship of effect of corporate governance on the ratio of short-term

debts on the assets (γ=0.13, p<0.01) and the effect of corporate governance on the ratio of total debts to the assets

(γ=0.18, p<0.01) document that there is a significant positive association between the corporate governance

variables and the ratio of short-term debts to the assets and between the corporate governance variables and the

ratio of total debts to the assets. This finding confirms the third and fourth hypotheses of the structural model.

In relation to the direct association between the effect of corporate governance on the cost of debt (γ=-0.17, p<0.01)

and the effect of corporate governance on the cost of capital (γ=-0.08, p<0.05), it is found that there is a significant

negative association between corporate governance and cost of debts and also between corporate governance and

cost of capital. Consequently, the fifth and sixth hypotheses are confirmed at 95 percent of significance. Based on

table 3, it is found that there is a significant negative relationship between corporate governance and the weighted

average of the cost of capital. It is then concluded that the corporate governance affects the weighted average of the

cost of capital at 95 percent of significance.

5.3 Predictive equations of the endogenous variables

Any one of the endogenous variables of a model areindicated in a structural equation and these equations are shown

in the table below:

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Table5. The predictive equation of the endogenous variables of a structural model

Multivariate Regression

coefficient

R2

errorvar Structural model Endogenous variable of the model

31% 69/0 111/0 = DL Dividend policy

37% 63/0 28/0 = -LTD The ratio of short-term debts to the

assets

35% 65/0 13/0 = STD The ratio of short-term debts to the

assets

18% 82/0 18/0 = TD The ratio of total debts to the assets

15% 85/0 17/0 = - Kd Cost of debts

2% 98/0 08/0 = - Ke Cost of owner’s equity

3% 97/0 08/0 = - WAC Weighted average of cost of capital

Figure1. Structural model in terms of the estimated coefficients

Corporate

governance

DL

LTD

STD

TD

Kd

Ke

WAC

0.111

0.28

0.13

0.17

0.08

0.08

0.18

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5.4 The findings of the hypotheses based on the measurement model

The measurement equation is provided in this section. Any one of the equations include the path coefficient

between the observed and latent variable, measurement error of the observed variable and its significance test based

on t value and adjusted R2 by the latent variable.

Table6. Findings related to the first hypothesis in the measurement model

Variables Estimated value Standard error t Sig. level

Co

rpo

rate

go

ver

nan

ce

INSOWN 116/0 4% **

44/2 01/0> p

EAUDIT 11/0 4% **

38/2 01/0> p

BRDSZE 056/0 3% *

63/1 05/0> p

DUALITY 049/0 3% 40/1 05/0< p

CEOD 41/0- 11% **

74/3- 01/0> p

NXRATIO 37/0- 33% **

07/4- 01/0> p

CEOCON 05/0- 3% *

57/1- 05/0> p

In terms of the path coefficient between the corporate governance variables, the coefficient values are all significant

except for CEO duality and t statistics shows that the ownership percentage of the institutional investors, the

presence of the independent auditors, board size, CEO influence, the ratio of non-executive members of the board

and CEO consistency measure the concept of corporate governance. Consequently, the first hypothesis of the

measurement model is confirmed at 95 percent of significance. Furthermore, table 6 shows the multivariate

regression coefficients.

Table7. Findings of R2 in the first hypothesis of the measurement model

Variable Squared coefficient of multivariate Errorvar

INSOWN 013/0 98/0

EAUDIT 012/0 97/0

BRDSZE 0035/0 99/0

DUALITY 002/0 99/0

CEOD 17/0 83/0

NXRATIO 11% 89/0

CEOCON 003/0 99/0

According to the above table, 1.3 percent of the variation of the corporate governance is explained by the

ownership percentage of the institutional investors. This amounts to 1.2 percent by the presence of the independent

auditor, 0.35 percent by the board size, 0.2 percent by CEO duality, 17 percent by the CEO influence, 11 percent by

the ratio of non-executive members of the board and 0.3 percent for the CEO consistency.

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Table8. Findings of the second hypothesis of the measurement model

Variable Estimated value Standard value t Sig. level

Dividend per share to the earnings per

share 71/0 04/0

** 04/10 01/0> p

In terms of the path coefficient between the ratio of dividend to the earnings per share and the latent variable of

dividend policy (λ=0.71, p<0.01), it is found that this ratio measures the concept of dividend policy. Therefore, the

second hypothesis of the measurement model is confirmed.

Table9. Findings of R2 of the second hypothesis of the measurement model

Variable Multivariate squared coefficient

R2

errorvar

Dividend per share to the earnings

per share 51/0 49/0

As shown by the table above, about 51 percent of the variance of the dividend policy is explained by the dividend

per share to the earnings per share ratio.

Table10. Findings of the third hypothesis of the measurement model

Variable Estimated value Standard error t Sig. level

Cap

ital

str

uct

ure

Total debts to the assets 32/0- 05/0 **

35/6- 01/0> p

Short-term debts to the

assets 79/0 03/0

** 53/14 01/0> p

Total debts to the assets 61/0 06/0 **

11/10 01/0> p

According to the findings of the above table, it is found that the ratio of short-term debts to the assets and the ratio

of total debts to the assets measure the capital structure. As a result,the third hypothesis of the measurement model

is confirmed at 99 percent of significance. The above below shows the findings related to the multivariate

regression coefficient.

Table11. Findings of R2 in the third hypothesis of the measurement model


R2

errorvar

Long-term debts to the assets 102/0 90/0

Short-term debts to the assets 46/0 34/0

Total debts to the assets 36/0 65/0

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Table above indicates that about 10.2 percent of the variance of the capital structure is explained by the ratio of

long-term debts to the assets and this amounts to 46 percent by the ratio of short-term debts to the assets and 36

percent by the ratio of total debts to the assets.

Table12. Findings of the fourth hypothesis of the measurement model

Variables Estimated value Standard error t Sig. level

Co

st o

f ca

pit

al Cost of debt 006/0- 04/0 149/0- 05/0< p

Cost of owner’s

equity 79/0 03/0

** 53/14 01/0> p

Weighted average

of cost of capital 54/0 03/0

** 11/9 01/0> p

Based on the above table, the path coefficients of the cost of capital are significant and t value describes that the

cost of owner’s equity and the weighted average of the cost of capital measure the cost of capital. As a result, the

fourth hypothesis of the measurement model is confirmed at 99 percent of significance.

Table13. Findings of R2 in the fourth hypothesis of the measurement model


R2

errorvar

Cost of debts 001/0 99/0

Cost of owner’s equity 46/0 34/0

Weighted average of cost of

capital 30/0 70/0

The findings show that 0.1 percent of the variance of the cost of capital is explained by cost of debts, 46 percent is

explained by the cost of owner’s equity and 30 percent is explained by a weighted average of the cost of capital.

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Figure2. Measurement model in terms of the estimated coefficients

Corporate

governance

Capital

Structure

Cost of

Equity

Dividend

INSOWN

EAUDIT

SRDSZE

DUALIT

Y

CEOD

NXRAT

OI

CEOCO

N

DIVPOL

LTD/ASSE

TS

STD/ASSE

TS

TD/ASSET

S

Kd

Ke

WACC 54/0

79/0

006/0

61/0

79/0

32/0

71/0

003/0

11/0

17/0

002/0

0035/0

012/0

013/0

12/0

15/0

13/0

21/0

11/0

14/0

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5.5 Relative significance of the determinants of the variables

Comparing the normalized factor loadings of any one of the determinants of corporate governance, capital structure

and cost of capital, the relative significance of any one of them in determining the corporate governance, capital

structure and cost of capital has been identified. Table 10 indicates the fully normalized factor loadings.

Table14. Results of the fully normalized factor loadings

Determinants of corporate governance Factor loadings

INSOWN 116/0

EAUDIT 11/0

BRDSZE 056/0

DUALITY 049/0

CEOD 41/0

NXRATIO 37/0

CEOCON 05/0

Determinants of capital structure Factor loadings

LTD/ASSETS 32/0

STD/ASSETS 79/0

TD/ASSETS 61/0

Determinants of cost of capital Factor loadings

Kd 006/0

Ke 79/0

WACC 54/0

The standardized factor loadings indicate that CEO influence is more significant than the other indicators with the

factor loadings of 0.41 percent. Additionally, among the other determinants of capital structure, the ratio of long-

term debts to the assets with the factor loadings of 0.79 is more significant than the other indicators. Among the

determinants of the cost of capital, the cost of the owner’s equity with the factor loadings of 0.79 is known to be

more significant than the other indicators.

6. Discussion and Conclusion

The analyzes revealed that there is a significant positive relationship between corporate governance and dividend

policy. This relationship confirms that the dividend is the result of the corporate governance quality. This finding is

consistent with the findings of Miton (2004), Kwalaski et al (2007) and Pronozit et al (2008). However, this study

does not confirm the findings of Pronozit et al (2006) who found there is a substitution relationship between cash

dividend and the corporate governance. The findings of Fakhari and Yousef Ali Tabar (2010) on 125 listed firms on

the Tehran Stock Exchange during 2004 to 2007showed that there is a significant inverse relationship between

corporate governance and dividend. The present study, however, did not conclude the same because the indicators

of corporate governance are different and the time interval is not the same. In terms of the direct relationship of

corporate governance impact on the ratio of long-term debts indicated that there is a significant negative

relationship between the corporate governance variables and the ratio of long-term debts to the assets. Jirapern et al

(2012) also found that the financial leverage and the corporate governance quality are inversely associated. The

result is consistent with the substitution assumption. This study proposes that the financial leverage works as a

substitute for the corporate governance. Debts mitigate the agency costs. Corporate governance is applied in a

similar method to mitigate the agency conflicts. Consequently, debts and corporate governance play the same roles

and might be substituted by each other. In the third and fourth hypotheses, the impact of corporate governance on

the ratio of short-term debts to the assets and the ratio of total debts to the assets are examined and the findings

confirm the significant positive relationship between the variables. The findings of the third and fourth hypotheses

confirm the results of Kami and Bildirick (2001), Kournaidi and Tourani Rad (2009), Bukepein and Arko (2009)

and Hasan and Butt (2009). The results of the third and fourth hypotheses are consistent with the findings of the

output assumption. Actually, this assumption states that capital structure is the result of the corporate governance

quality. It can be explained so that the companies with lower quality of corporate governance are confronted with

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more agency problems. The directors are also able to prioritize their benefits to the benefits of the shareholders. In

doing so, the debts play an important role in controlling the agency costs. In terms of the impact of corporate

governance variables on the cost of capital of the Tehran listed firms, the findings of the fifth, sixth and seventh

hypotheses represent that there is a significant negative relationship between corporate governance and cost of

debts, cost of owner’s equity and the weighted average of the cost of capital. These findings are consistent with the

conclusions of Lambert et al (2007), Fam et al (2007) and Rourte (2008). Chen et al (2009) examined the

relationship between corporate governance, investors’ protection and the cost of the owner’s equity and found that

there is a significant negative association between different levels of corporate governance and the cost of capital.

Corporate governance provides some mechanisms aimed to mitigate the agency risks resulted from the information

asymmetry. A strong corporate governance system reduces the problems associated with the inconsistent selection

and ethical risk and finally reduces the cost of the owner’s equity. Inversely, a weak corporate governance increases

the agency risk and finally increases the cost of capital.

7. Applicable Suggestions

The following suggestions are provided based on the findings of the study:

1. Corporate governance is a main factor for the regulators, industry managers and other analysts. On the other

hand, cost of capital is of high significance for the growth and development of the firms. The findings show that a

good corporate governance impacts the mitigation of the cost of capital and it facilitates the attraction of the

investors. As a result, the decision makers are offered to take into account the information related to the corporate

governance mechanisms for the further attraction of the investors.

2. The findings represented that there is a positive association between the corporate governance mechanisms and

the dividend policy. The investors are offered to pay sufficient attention to the corporate governance mechanisms in

addition to the dividends. This is because the opportunistic directors employ dividends as an instrument to cover

the weaknesses of corporate governance. Discovering this relationship, it is essential to establish the corporate

governance requirements by the stock exchange officials.

3. Based on the findings. It is found that the most significant element of the capital structure is the ratio of short-

term debts to the assets and the scholars are offered to pay more attention to this factor as an agency of the financial

leverage.

4. According to the results, CEO influence is found to be the strongestindicator of corporate governance. The

Iranian firms are then suggested to select the chief of the board as an executive individual. This is because the CEO

is a source of the executive power and controls the board of directors. Furthermore, the CEO is responsible for

controlling the meeting orders and direct them. The conflict of interests of CEO and shareholders makes the

influence of CEO more problematic.

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