Board Characteristics, Ownership Structure and Agency Costs: UK Evidence

Abstract

The term “Corporate Governance” always proliferates after large accounting scandals and crises; practitioners claim that governance mechanisms are the cause of these failures, and worldwide reforms take place after each failure; however, these reforms did not succeed in preventing the subsequent falls down. Although corporate governance mechanisms are introduced to monitor and control the managerial opportunistic behaviour in order to reduce the agency costs; most of the prior studies were directed towards investigating the role of governance mechanisms in enhancing firm performance as an indirect proxy of lower agency conflicts, and hence, lower agency costs. This study adds to the debate around the usefulness and the effectiveness of the corporate governance mechanisms in controlling the managerial opportunistic behaviour and reducing agency costs.
This study contributes to the governance literature by investigating and comparing the impact of a comprehensive set of governance mechanisms reflecting a wide spectrum of board characteristics and ownership structure on agency costs over the period 2005-2011; in addition to providing a comparison of before and after the financial crisis periods using a large sample of firms listed in FTSE All-Share index. In doing so, two different agency costs proxies are utilised; asset utilisation which reflects the managerial efficiency; and the interaction of free cash flow with growth opportunities which reflects investment decisions agency costs. This comparative analysis extends the governance literature that investigated the pre and during the crisis periods by adding the pre and post the 2008 financial crisis comparison. Lastly, this study considers more than one theoretical paradigm; the empirical evidence lends the support to the agency and resource dependence perspectives and provides partial support to the stewardship view.
The results clearly show that not all governance mechanisms lead to lower agency costs; thus, one prescribed structure does not fit all. Moreover, the efficiency of the governance mechanisms is directly affected by surrounding economic conditions (e.g., steady and abnormal conditions); in other words, governance mechanisms which help in reducing agency costs during the normal economic condition could turn out to be useless, inefficient and in some cases detrimental to the managerial effectiveness after the financial crisis. Moreover, the reported results support the claim that interrelation between the different governance mechanisms should be considered in future governance studies.