THE MEDIATING EFFECT OF AGENCY COSTS ON THE NEXUS BETWEEN OWNERSHIP STRUCTURE AND CORPORATE RISK AMONG FIRMS LISTED AT THE NAIROBI SECURITIES EXCHANGE, KENYA
Abstract
Ownership structure of a firm is important in corporate governance since it affects the incentives of managers and thereby the efficiency of the firm and corporate risks. The nature of firm ownership can influence the level of agency costs, which in turn affects the level of corporate risk. Agency costs, arising from the inherent conflict of interest between shareholders and management, present a complex challenge to corporate decision-making. The current topic is of significant relevance to both the theoretical framework of corporate finance and the practical concerns of corporate governance. Understanding the nuances of how agency costs influences the relationship between ownership structure and corporate risk is pivotal in addressing the potential misalignments that can be detrimental to shareholder interests. Agency costs arise from the separation of ownership and control in a corporation, where shareholders (owners) delegate decision-making authority to managers (agents). Changes in ownership structure are often driven by efforts to address agency problems, improve corporate governance, and align the interests of managers with those of shareholders. The relationship between ownership structure and corporate risk is influenced by how ownership structure affects agency costs. By implementing effective monitoring mechanisms, aligning incentives, reducing information asymmetry, and fostering a market for corporate control, ownership structures can influence the level of agency costs and, consequently, the uncertainty and variability associated with a company's financial performance and the potential impact on its value(corporate risk). Managers, seeking to maximize their own interests, may engage in risk-taking behavior that does not align with the risk preferences of shareholders. If the incentive structure is poorly designed or does not adequately tie executive compensation to company performance, managers may have little motivation to manage risk prudently. Ineffective incentive structures can contribute to increased corporate risk. Effective corporate governance, proper alignment of incentives, transparency, and strong risk management practices are essential for mitigating the impact of agency costs on corporate risk and ensuring the long-term sustainability of the firm. This research focused on three key theories: agency theory, the mean variance-portfolio theory, and stakeholder theory. Key variables analyzed include ownership structure, which was operationalized in terms of managerial ownership, foreign ownership, government ownership and corporate ownership. Agency costs was measured using total annual operating expense to total annual revenue while corporate risk was estimated based on volatility of firm’s earnings (standard deviation of return on asset, SDROA). The study was guided by the positivist approach. Causal survey research design was adopted. The study population was sixty (64) firms at NSE as at 31st December 2021. Secondary data was collected within a span of 11 years; 2011 to 2021. The regression model of ownership structure on corporate risk was significant. The findings further indicate that agency costs has a significant mediating effect on the relationship between ownership structure and corporate risk among firms listed at the Nairobi Securities Exchange.
Keywords: Corporate Risk, Agency Costs, Ownership Structure, Nairobi Securities Exchange
References
Amihud Y. & Lev B., 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617.
Andries, A. M., Balutel, D., Ihnatov, I., & Ursu, S. G. (2020). The nexus between corporate governance, risk taking, and growth. PloS one, 15(2), e0228371.
Ang, J.S, Cole R.A & Lin J. W (2000). Agency Costs and Ownership Structure. The Journal of the American Finance Association Volume 55, Issue1.
Beasley, M. S. (1996). An empirical analysis of the relation between the board of director composition and financial statement fraud. The Accounting Review, 71(4), 443-465.
Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81(3), 637-654.
Boubakri, N., Cosset, J. C., & Saffar, W. (2013). The role of state and foreign owners in corporate risk-taking: Evidence from privatization. Journal of Financial Economics, 108(3), 641-658.
Bradford, W., Du, Q. & Sokolyk, T. (2018). Firm ownership, agency costs, and firm performance. Journal of Applied Finance, (23), 1-46
Chinelo, E. O. & Iyiegbuniwe, W. (2018). Ownership structure, corporate governance and agency cost of manufacturing companies in Nigeria. Research Journal of Finance and Accounting, 9(16), 16-26.
Chun, S., & Lee, M. (2017). Corporate ownership structure and risk-taking: evidence from Japan. Journal of Governance and Regulation. https://doi. org/10.22495/jgr_v6_i4_p4.
Donaldson, T., & Davis, J. H. (1991). Stewardship theory or agency theory: CEO governance and shareholder returns. Australian Journal of Management, 16(1), 49-64.
Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3-56.
Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. The Journal of Law and Economics, 26(2), 301-325.
Hastori, H., Siregar, H., Sembel, R., & Maulana, A. (2015). Agency costs, corporate governance and ownership concentration: The case of agro-industrial companies in Indonesia. Asian Social Science, 11(18), 311-319.
Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. (2012). Strategic management: Concepts and cases: Competitiveness and globalization. Cengage Learning.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
Khan, R., Khidmat, W. B., Hares, O. A., Muhammad, N., & Saleem, K. (2020). Corporate governance quality, ownership structure, agency costs and firm performance. Evidence from an emerging economy. Journal of Risk and Financial Management, 13(7), 154.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2000). Agency problems and dividend policies around the world. The Journal of Finance, 55(1), 1-33.
Langit, S., & Adhariani, D. (2017). Ownership Structure and Company's Risk-Taking Behaviour. In International Conference on Business and Management Research (ICBMR 2017) (pp. 52-64). Atlantis Press.
Lehn, K., Patro, S., & Zhao, M. (2009). Determinants of the size and structure of corporate boards: 1935–2000. Journal of Financial Economics, 93(2), 169-198.
Merton, R. C. (1977). An analytic derivation of the cost of deposit insurance and loan guarantees: An application of modern option pricing theory. Journal of Banking and Finance, 1(1), 3-11.
Mutende, E. A. (2018). Free cash flows, agency costs, firm characteristics and performance of firms listed at the Nairobi Securities Exchange, Kenya (Doctoral dissertation, University of Nairobi).
Nguyen A. H, Doan D.T & Nguyen L.H (2020). Corporate governance and agency cost: Empirical evidence from Vietnam. Journal of Risk and Financial Management, ISSN 1911-8074, MDPI, Basel, Vol. 13, Iss. 5, pp. 1-15, https://doi.org/10.3390/jrfm13050103
Nguyen, T., Locke, S., & Reddy, K. (2015). Ownership concentration and corporate performance from a dynamic perspective: Does national governance quality matter?. International Review of Financial Analysis, 41, 148-161.
Padachi K. (2016), Assessing Corporate Governance Practices of Mauritian Companies, International Journal of Accounting and Financial Reporting, 6(1), 38-71.
Singh, M., & Davidson, W. N. (2003). Agency Cost, Ownership Structure and Corporate Governance Mechanisms. Journal of Banking and Finance, 27,793-816.
Tirole, J. (2006). The theory of corporate finance. Princeton University Press.
