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International Journal of Accounting and Financial Reporting
ISSN 2162-3082
2018, Vol. 8, No. 3
http://ijafr.macrothink.org
256
Agency Costs, Corporate Governance and the Nature of
Controlling Shareholders: Evidence From French Listed
Firms
Dabboussi Moez
College of Humanities and Administrative Sciences
Department of Business Administration
Jouf University, Sakaka 72388, Saudi Arabia
Tel: 966-505-296-703 E-mail: dabboussi.moez@yahoo.fr
Received: September 7, 2018 Accepted: September 18, 2018 Published: September 26, 2018
doi:10.5296/ijafr.v8i3.13621 URL: https://doi.org/10.5296/ijafr.v8i3.13621
Abstract
This paper examines the impact of internal corporate governance on agency costs for French
firms from 2000 to 2015. Our results reveal that shareholders themselves are not a homogenous
group since they have no single common investment horizon. We found that managerial
ownership is more effective in mitigating operational expenses. However, they take advantage
of excessive spending on indirect benefits. We show that board of directors does not serve as a
significant deterrent to excessive discretionary expenses. Finally, we found that dividend
policy is a useful tool to reduce agency conflicts by reducing cash that is available for
discretionary uses.
Keywords: Agency costs, Corporate governance, Controlling shareholders, French listed
firms
JEL Classification: G30, G32, G35
1. Introduction
How to reduce agency problems that can arise between shareholders and managers? This is one
of the big questions when corporate governance is addressed. Indeed, during the last decades,
the issue has attracted the attention of many researchers and regulatory authorities. Its origin
dates back to the debate initiated by Berle and Means (1932) that highlighted the problems
inherent in the decision-ownership dichotomy. Since then, many researchers have become
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interested in the study of the agency problem, giving rise to several propositions about the
firm's management structure. Indeed, Jensen and Meckeling (1976), founder of the agency
theory, examined the conflicts of interest that arise between managers and shareholders when
ownership and control are separated. To reduce this conflict, corporate governance theory
provided answers as to the maximization of firm value and the elimination of any source of
organizational inefficiency. According to Gugler et al. (2003 shows that a reliable and
transparent governance system depends on its ability to align the interests of managers and
shareholders and to maximize, as a result, shareholders wealth. Similarly, Swanson and Tayan
(2011) and Damodaran (2015) defined corporate governance as a set of control mechanisms
that the organization adopts to prevent or to dissuade managerial self-interest from engaging in
activities disfavoring stakeholders‟ well-being.
In the literature, many internal corporate governance mechanisms are well documented. They
mainly relate to the company's operational stakeholders who can control managerial decisions,
Parrino et al. (2012). Therefore, the purpose of this study is to provide a clear vision of
governance as well as its components. Specifically, we assess the effectiveness of these
governance mechanisms through the application of the Corporate Governance Codes and
Principles in the French context. The rest of the paper is organized as follows. Section 2
introduces the French corporate governance system and its institutional environment. Section 3
provides a literature review and hypothesis development. Section 4 presents the research
design. Section 5 presents a discussion of the implication of the results. Concluding remarks
and presents some directions for future research are presented in the last section.
2. French Corporate Governance System and Its Institutional Environment
Extending share ownership of French companies has favored establishing a debate about
corporate power. Critics focused on the lack of a legal framework in order to push the CEO to
be more transparent. Moreover, after a series of scandals (Enron, Andersen, Worldcom) that
affected the world economy involving large companies, some economic fundamentals have
been shaken. As a result, these scandals triggered a debate on the firm‟s organizational and
operational outlook. In other words, a certain numbers of legal and accounting
recommendations linking the different stakeholders were proposed by the AFEP (Note
1)-MEDEF (Note 2) Corporate Governance Code for Listed Companies. First, the Viénot1
report, published in July 1995 under the name of "The Board of Directors of listed companies",
was primarily concerned with the Board of Directors of publicly listed companies, in view of
clarifying their mission and making their business more effective. The report recommended the
removal of cross mandates, the limitation of the number of directors in the Board of Directors,
the use of independent directors and the creation of Board-operational committees.
Second, the Viénot 2 report, published in July 1999, took a broader perspective by promoting
an approach giving companies the possibility of separating the positions of Chairman of the
Board of Directors and the Chief Executive Officer. This report updates the notion of an
independent Director with details on the notion of independence and strengthens the role of
independent directors and the independence conditions for the exercise of their power. It also
recommended the quick provision of financial information and communication for
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shareholders to be the role of general assemblies.
Third, the Bouton report (2002) has been developed as a result of the Enron crisis and aims at
restoring investors‟ confidence. The report suggested undertaking a number of improvements
to the Board of Directors (strengthening of independence of directors, a higher degree of
formalization, quality of information, better assessment), committees (audit, remuneration and
nomination committees), independence of Auditors and financial information.
With regard to the main legal texts adopted in France, the legal framework about governance in
this country is subject to European directives issued by the European Parliament. This
guideline was established in the Winter report, published in 2002, which aimed at modernizing
the right companies and strengthening corporate governance standards. This report has
established 10 priorities including the mandatory publication of an annual governance report of
listed companies, a set of rules on shareholder rights, strengthening the influence of
shareholders and transparency about Executive remuneration as well as a better coordination of
corporate governance codes nation-wide. In the French context, three recent texts have
attracted special attention. First, the law on the new economic Regulations (Act NRE) that
complemented the Viénot report (1995) and the Button report (2002) and emphasizing the
separation between management and control functions in order to strengthen the independence
of Board members. Then, the financial security law (2003) has been designed as a French
response to the trust crisis of financial markets caused by the several scandals (Enron,
Vivendi...). The law aimed at strengthening the supervisory authorities‟ powers, with the
creation of the financial markets authority (AMF) in an effort to achieve better protection for
investors. Additionally, it aimed at strengthening the role and independence of Auditors as well
as improving the quantity and quality of information provided to shareholders. Finally, the
2005 law on the modernization of the economy has strengthened the legal requirements about
disclosing information on executive compensation, especially its components and its
evaluation criteria.
3. The Literature Review and Research Hypotheses
Among an array of control mechanisms, Agency theory includes mechanisms that discipline
managers and force them to act in shareholders‟ interest. Of these mechanisms, we distinguish
ownership concentration, the presence of large shareholders, board structure and size, quality
audit committees, debt effect, dividend policy and finally the Executive stock option payment.
3.1 Impact of Ownership Concentration on Agency Costs
Prior studies such as that of Jensen and Meckling, (1976), Demsetz (1983), Demsetz and Lehn,
(1985), and Shleifer and Vishney (1986)) showed that when ownership is concentrated,
management control would be effective. Indeed, blockholders agree to control managers and
help to foster value-maximizing resource allocation. In addition, ownership concentration
allows for rationalizing decision-making about dividend distribution. Examining a sample of
600 Canadian listed firms, Gadhoum (2000) found that a high ownership concentration of
allows for establishing a meaningful relationship between shareholders and management by
reducing conflicts of interest and information asymmetry. Similarly, La Porta et al.(2000b) and
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Shleifer and Vishny (1997) show ownership concentration lessens these distortions by
reducing free cash flow for discretionary expenditures and by imposing, for example, greater
financial discipline over managers. Although ownership concentration has been strongly
considered as a mechanism of effective internal control to solve, at least in part, agency
problems, we believe that, under certain conditions (such as high levels of capital
concentration), it will lead to limited effectiveness when larges shareholders‟ interests diverge
from those of the stakeholders. Therefore, we formulate the following hypothesis:
Hypothesis 1: ownership concentration has a negative impact on agency costs.
3.2 The Presence of Controlling Shareholders
Prior studies such as that of Parrino et al. (2012) show that large shareholders have an interest
in inciting management to maximize shareholder value. However, Damodaran (2015) indicate
that there is no magic bullet that will somehow turn bad managers into good managers or
guarantee superior performance. In our study, it is important to determine the role of the
different owners and to identify the factors behind their decisions. In what follows, we identify
the disciplinary role of each shareholder in mitigating agency conflicts.
3.2.1 Managerial Ownership and Agency Costs
The literature identified two great forms of managerial discretions, which can lead to agency
costs. First, the CEO often engages in economic activities that may improve their non-labor
income, Jensen and Meckling (1976). This kind of behavior reduces firm wealth by increasing
their costs. Second, managers may also increase their power and prestige through long-term
investments that can increase firm size rather than benefits. In order to control this discretion,
managerial ownership is considered as the most advantageous form to reduce agency costs. In
fact, CEO becomes shareholder through incentive-based contracting which stipulates the right
to profit from cash flow (incentive plans, acquisition of share capital, stock option plan.). Share
ownership confers to owners the right to vote in the general assembly and the right to be elected
to the administrative board. Consequently, the manager-shareholder position takes a dual
function and is remunerated twice (wages and dividends), incurring the same shareholder risk.
This justifies their motivation to preserve the company's interests, Fu and Wedge (2011). In
addition, Maury (2004) support Jensen and Meckling (1976) by adding that the smaller the
share held by the manager, the more this latter is able to adapt firm goods into particular
advantages. The presence of managers in the ownership structure encourages them to act in
favor of value maximization. It enables them to reduce control cost supported by shareholders
who seek to maximize their wealth, in particular through dividends distribution. Therefore, we
formulate the following hypothesis:
Hypothesis 2: managerial ownership negatively affects agency costs.
3.2.2 Relationship Between Institutional Investors and Agency Costs
Considered to be the major players in contemporary economy through their economic weight
and their intervention, the influence of institutional investors (Note 3) on corporate governance
and agency problems remains ambiguous. According to Agency theory, institutional
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shareholders with a significant capital share play a key role in alleviating agency problems.
This is because they have the resources and the expertise to monitor management decisions at a
lower cost, Henry (2004). According to Pound (1988), institutional investors can adopt the
'wall street walk' strategy by selling their stakes not to vote against the managers. Similarly,
they may vote in favor of managers because of business relations with managers to identify
conflicts of interest. However, institutional investors have an indirect influence on firm by
ensuring the revocation of some Board Members. Also, they can vote against the proposals of
the manager by highlighting their own measures or by expressing their displeasure by selling
their shares; "voting with their feet", Swanson and Tayan (2011). Of their side, Doukas et al.
(2000) showed that agency costs are not influenced by institutional ownership. They are
passive towards control as they tend to diversify their portfolios. Therefore, we formulate the
following hypothesis:
Hypothesis 3: institutional ownership negatively (positively) affects agency costs.
3.2.3 The Relationship Between Family Ownership and Agency Costs
The separation between the control and management functions in family businesses allows us
to distinguish two types of conflicts. The first takes place when the family is the single majority
shareholder. In this context, one speaks of a conflict of interest with minority shareholders. On
the other hand, when families delegate an external manager, the second conflicts between
managers and shareholders will arise, Morck et al. (1988). In the absence of a growth
opportunity, family ownership plays an important role in reducing agency conflicts through the
disciplinary role of managers, SanMartin-Reyna and Duran-Encalada (2012). This argument
validates the hypothesis that ownership concentration in family businesses provides better
supervision on managers. In other words, when they face low investment opportunities, they
may be tempted to act opportunistically. In this case, a high level of family ownership is to
compensate for the reduced level of investor protection. Family control over ownership
structure of firms with growth opportunities could lead, to some extent, to squandering these
opportunities, De Andres et al. (2005).
Hypothesis 4: There is a positive relationship between family ownership and agency costs
3.2.4 The Relationship Between Foreign Ownership and Agency Costs
An abundant literature on foreign investors suggests that they play a more important role than
local investors in improving corporate governance. In effect, the basic idea is that firm‟s follow
the corporate governance model of their countries of origin unless the firm is a subsidiary of a
foreign company. These foreign administrators are shareholders who hold enough shares that
enable them to absorb high control costs, therefore, they are motivated to check and correct
management discretions, Grossman and Hart, (1988). However, Chen et al (2013) argue that
foreign ownership know how to deal with opportunistic managers, mitigate agency conflicts in
different international and cultural contexts and improve financial transparency. Subscribing to
the resource dependence theory, Pfeffer (1972) pointed out that foreign sources present a
mechanism of subcontracting which contributes to capital financing. In addition, foreign
investors are more fundamental factors that help separate between owners and shareholders
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and also help the company to extend its control over managers‟ decision-making. Finally, choi
and choi (2013) argue that the higher level of foreign ownership leads to a reduction of agency
cost. Therefore, we formulate the following hypothesis:
Hypothesis 5: agency costs will be low when foreign shareholders are a majority.
3.3 Board Characteristics and Capital Agency Costs
The effect of board characteristics on resolving conflict of interests between managers and
shareholders drew the attention of several researchers, Adam et al.(2010). To ensure that the
Board works effectively, two features should be checked; its size and the presence of
independent directors.
3.3.1 The Role of Board Size in Mitigating Management Opportunism
Jensen (1993) and Lehn et al. (2004) provides that Board of directors is responsible to
represent and defend shareholders‟ interests, choose managers and watch them so that they do
not act against other stakeholders. The literature also agrees on the importance of board size in
resolving agency conflicts between managers and shareholders. For example, Beiner et al.
(2004) found that among the consequences of a large number of administrators is the dilution
of voting power, which is likely to reduce the firm's effectiveness. On the other hand, a small
board may not be able to pursue its responsibilities in a satisfying way, which is detrimental to
overall firm performance. According to Raheja (2003), there are conditions under which a
small-sized board helps to mitigate agency conflicts between managers and shareholders. Sign
and Davidson (2003) found that the larger the Board, the more available resources to monitor
managers „decisions. In their turn, Bhagat and Black (1999) found that size may have a dual
effect (positive and negative) on agency costs. Others found that an optimum Board sizefor
each firm rather than a uniform size for all firms is hypothesized, Hermalin and Weisbach
(2003). Therefore, we propose the following hypothesis:
Hypothesis 6: board size has a positive (negative) impact on capital agency costs.
3.3.2 Independence of Board Members
Several studies suggest that independent directors are best placed to control managers and are
more likely to work for the interest of shareholders, Agrawal and Knoeber (1996) and Henry
(2004). In the same line of reasoning, Hermalin and Weisbash (1998) support the idea that
boards usually include outside and internal directors with diverging motivations. Depending on
the proportion of internal or external directors, the Board will be more or less independent. In
addition, the number of Board members should be sufficient to make it work in an efficient and
effective way to maximize long-term profitability for shareholders. However, other authors
have found that a Board dominated by managers can lead to possible conflicts between internal
directors and managers in an attempt to expropriate shareholders wealth. Raheja, (2005). In
addition, Brealey et al (2014) argued that boards are sometimes portrayed as passive stooges
who always champion the incumbent management.
Hypothesis 7: independent directors have a negative impact on agency conflicts.
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3.4 The Relationship Between Audit Quality and Agency Costs
Agency theory stipulates that an audit committee mitigate the inherent moral hazard problem
between the principal and the agent, which gives rise to agency costs. In this regard, external
auditors are supposed to strengthen governance structure while minimizing divergence of
interests. Reaching these objectives highly depends on audit quality which depends in its turn
on two factors; competence and independence. Several researchers found that audit quality
strongly depends on membership to the biggest audit firms, as these latter have the reputation
as well as the ability to absorb the blame for the loss of a mandate in case of accounts
declassification, Klein and Leffler (1981). This type of Auditor plays an important role in
monitoring financial information quality, and can therefore be considered an important element
of the governance process, Alfraih (2016). Accordingly, high quality audit committees may
limit opportunistic managers and mitigate risk while improving financial statements credibility
and the work of the Board. Therefore, we propose the following hypothesis:
Hypothesis 8: A 'Big four' audit has a negative impact on agency costs
3.5 The Role of Debt
Debt provides managers with incentives to focus on maximizing cash flow and limit bad
managers from wasting shareholder capital on unprofitable projects, Kayo and Kimura, (2011)
and Parrino et al. (2012). In addition, debt plays a key role in motivating managers to be more
effective by preserving and increasing their security and protects bondholders against
over-investment risk, Onofrei et al. (2015) and Damodaran (2015). However, managers often
dispose of a high proportion of their wealth, as a function of firm success. As a result, they tend
to prefer less risk than shareholders who hold diversified portfolios. In the same line of
thinking, the pecking order theory suggests a positive relationship between investment
opportunities and leverage. This assumes that capital structure results from information
asymmetry between managers and investors. This theory acknowledges that the manager is
rational, but not necessarily opportunistic, Myers (1984). In a stage of firm maturity, debt no
longer has the same disciplinary effect on managers, Kayo and Kimura, (2011). As a result, we
assume that there is either a positive or a negative relationship between debt and firm value as
stated in the following hypothesis:
Hypothesis 9: debt negatively (positively) correlates to agency costs.
3.6 The Disciplinary Role of Dividends Distribution
Financial theorists assumed that dividends distribution policies are disciplinary mechanisms of
agency conflicts between shareholders and managers. In fact, Jensen (1986), Easterbrook
(1984) and Quiry et al (2014) showed that an increase in the dividends payout ratio allows for
resolving these conflicts by limiting free cash flow and, accordingly, managerial discretion.
The latter will have to issue new shares in order to maintain level of investment. This type of
capital increase requires managers to provide relevant information to shareholders, allowing
them to reassess firm value. However, dividend can also generate conflicts between
shareholders and creditors. In such a context, the interests of shareholders and managers are
confused. They can make decisions about appropriating much of firm value at the expense of
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creditors. Indeed, shareholders could get wealth at the expense of bondholders by increasing
firm risk, resulting in a decrease in bonds value. They can also adopt a suboptimal investment
policy and pay dividends with uncommitted investment funds of projects with a positive net
present value.
Hypothesis 10: dividends has a negative impact on capital agency costs
3.7 Stock Options: An Incentive Mechanism for Managers
Stock options give managers the right to buy their company's shares in the future at a fixed spot
price. According to Fama (1980), stock options include fixing compensation on managerial
performance. They encourage managers to maximize capital value to receive the option of the
highest possible gain. Similarly, Jensen and Meckling (1976), Parrino et al.(2012) and Berk
and Demarzo (2014) considered that the most effective way to align the interests of managers
with those of shareholders is a well-designed compensation package that rewards executives
when they do what shareholders want them to do and penalizes them when they do not.
However, the introduction of this type of compensation seems a little difficult as it requires the
implementation of procedures that measure managers‟ performance. If the interests of
managers and shareholders converge, this promotes the emergence of a conflict with creditors.
In this case, the company will focus on the highly risky projects in order to increase option
value available to shareholders. In these circumstances, the manager may opt for riskier
investments. According to Berk and Demarzo (2014) options are often attributed to the
currency "at the money", meaning the spot price is equal to current currency rates. Therefore,
managers are encouraged to be sensitive to bad news until the options are granted (spot price is
down) and good news after the options are granted.
Hypothesis 11: Stock options compensation has a negative impact on agency conflicts.
4. Research Design
4.1 Sample Data Collection
To determine the impact of corporate governance on agency costs with the presence of
controlling shareholders, we use a sample of French firms included in index CAC All Tradable
over the period 2000-2015. We end up with 125 French firms for our empirical analysis. We
refer to several data sources. First, our firm financial data come from worldscope database.
Second, ownership structure, board characteristics, External Audit Committee and CEO stock
option compensation data are derived from annual reports. Table 1 shows the classification of
125 firms by sectors.
Table 1. Classification of firms by sectors
Sectors
Number of firms
Percent %
Technology
28
22.4
Consumer services
22
17.6
Industry
21
16.8
Consumer good
15
12
Healthcare
10
8
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Community services
8
6.4
Software
8
6,4
Basic Materials
5
4
Telecommunication
4
3,2
Oil and gas
4
3,2
Total
125
100 %
4.2 Variables Definition
4.2.1 The Dependent Variable: Agency Costs
Previous literature has suggested many proxies for agency cost. In our study, we focus on direct
agency costs (Note 4) which should result from the inefficient allocation of assets. We use four
measures of agency costs such Asset Utilization ratio (AUR), Operating expenses ratio
(Ope_Exp), Selling, general and administrative expenses (Adm_Exp) and Over-investment
Risk (Over_Invest).
- Asset Utilization ratio (AUR)
We use the asset turnover ratio as an inverse proxy for agency costs. This ratio measures the
effectiveness which the manager allocates assets to generate sales revenue, Truong and Heaney
(2013). A high ratio means that managers take decisions that improve a firm‟s overall
performance, create value for shareholders and shows that agency costs are low. Conversely, a
low ratio shows that managers take bad investment decisions resulting in low income.
Similarly, managers in this scenario consume excessive non-performing assets such as cars,
fancy space office and resort facilities, (Ang et al. 2000; Fleming et al. 2005). Therefore, this
ratio negatively relates to agency conflicts of equity (Note 5) between shareholders and
managers.
- Operating expenses ratio (Ope_Exp)
Several studies have considered operating expenses ratio as a measures managers‟
effectiveness in controlling operational costs, including the excessive consumption of indirect
benefits and other direct agency costs (Note 6). According to Singh and Davidson (2003), a
relatively high ratio of operational expenses may indicate excessive spending on trading
activities, which could be a signal that shareholder wealth is being expropriated by managers
who tend to divert firm resources by raising operational expenses or investing in negative net
present value projects, Shleifer and Vishny (1986). Therefore, this ratio should positively relate
to agency costs.
- Administrative expenses (Adm_Exp)
Administrative costs represent a significant component of business operations, Hilton and Platt
(2014) .This measure should reflect significantly managers „discretionary behavior towards the
company‟s resources allocation, as it can be a result of overspending on indirect benefits that
include salaries, commissions collected by managers to facilitate transactions, travel costs,
advertising and marketing costs, rent and other public services (Note 7). According to
Anderson et al (2002), managers can retain unused resources to avoid personal consequences
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of retrenchment, such as loss of status, which contributes as consequence to excessive cost
behavior. In addition, Eugene et Ehrhardt (2014) suggest that manager, rather than focusing on
maximizing firm value, may spend too much time on external activities, such as serving other
companies' boards of directors, or non-productive activities, such as golf and traveling.
Therefore, the higher administrative expenses ratio should face agency costs between
managers and shareholders.
- Over-investment Risk (Over_Invest)
The free cash flow theory, presented by Jensen (1986a), argues that managers have
discretionary behaviors aver the firm investment decision with are detrimental to the
shareholders wealth. Managers may become tempted to pursue their personal wealth or
otherwise spend excess cash in ways not in the shareholders' best interests. Similarly, when free
cash flow is positive, managers prefer to “stockpile” it in the form of marketable securities
instead of returning the money to investors. They also may paying too much for the acquisition
of another company, Eugene et Ehrhardt (2014). As a result, over-investment is when managers
engage several investment projects that do not maximize shareholder wealth, creating conflicts
of interests, reducing thus firm value and limiting consequently future growth opportunities,
Myers (1977). In our study, over-investment risk is when free cash flow is positive as well as
value firm measured by of tobin's Q is below sector average.
4.2.2 The Independent Variables
Our research model includes a set of internal corporate governance variables representing
ownership structure, the board characteristics, audit committee, managerial compensation and
capital structure. Several control variables are also included. Consistent with prior studies
(Holmstrom 1989, and Warren et al. 2014), we use the firm's tangible assets. Moreover, we
include the natural logarithm of total assets as a proxy for firm, McConnell and Servaes, (1990).
Finally, we use firm age, Agarwal and Gort (2002). Table 2 provides information on the
measures of these variables that were adopted from previous related studies.
Table 2. Variables, definitions and sources
Variable
Definition
Sources
AUR
Total sales to total assets ratio
Worldscoop
Ope_Exp
Discretionary operational expenses to total assets ratio
Worldscoop
Adm_Exp
Administrative expenses to total sales ratio
Worldscoop
Over_invest
Dummy variable that takes1 if Tobin’s Q is below sector average and free cash flow is
positive, zero otherwise.
Worldscoop
Bloc
Percentage of shares owned by the three largest shareholders
Annual report
Man_ Own
Dummy variable thattakes1 if managerial ownership is more than 50%, zero otherwise.
Annual report
Inst_ Own
Dummy variable that takes1 if institutional ownership is more than 50%, zero otherwise.
Annual report
Fam_Own
Dummy variable that takes1 if Family ownership is more than 50%, zero otherwise.
Annual report
For_Own
Dummy variable that takes1 if foreign ownership is more than 50%, zero otherwise.
Annual report
B_Size
The number of directors on the board
Annual report
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4.3 Model Specification and Methodology
In this study, our methodology consists in estimating three regressions, the difference between
them being the measurement of the dependent variable. The model will be estimated by using
the panel data method. Heteroscedasticity and autocorrelation are the two common problems
that normally exist in a panel data analysis. Thus, the Breush-Pagan-Godfrey test, the Modified
Wald test and the Wooldridge test are used to identify these problems respectively. Additionally,
panel data technique, namely Prais–Winsten (PCSE) regression, is applied to account for these
problems by using Stata Statistical Software: Release 13. The model to be tested is presented in
the following form:
- Where i indicate a particular company, t denotes the time in years, ɛi,t is a stochastic error
term.
-Descriptive Statistics of All Variables
Table 3 present the descriptive statistics of corporate governance and agency costs variables
used for the final sample of 2000 firm-year observations over the period 2000–2015. We find
that the average firm agency cost is 0.9654, 0.9668 and 0.3432, as measured by the asset
allocation ratio, operational expenses and sales, general and administrative expenses. For the
over-investment risk variable, it is observable at 42,35% during the study period. The number
of board director‟s ranges from 3 to 24. This makes of France the country with a high number
of administrators. On average, firms in our sample have boards of directors consisting of nine
directors (value close to the required maximum of 12 members). Also, board independence has
an average of 34.70% with a minimum of 0% and a maximum of 94.11%. Again, audit quality
is around 75,20% of the sample, indicating that companies are audited by a Big 4. The mean for
the dividend payout variable is 25,76. It shows that firms give high enough dividend payout to
stockholders The mean of the total debt ratio is 18,09 % which shows that the debt financing
of all the companies in our sample is less than half of their assets. In addition, an examination
of CEO compensation shows that, on average, 46.90 % of manager‟s benefit from stock
B_Ind
The number of independent outside directors to the total number of directors on the
board ratio
Annual report
Audit
Dummy variable that takes 1 if the auditor is Big Four, zero otherwise.
Annual report
Option
Dummy variable that takes1 if the CEO compensation structure includes stock options,
zero otherwise.
Annual report
Debt
Total debt to total assets ratio
Worldscoop
Div
Common Dividends (Cash)/ (Net Income before Preferred Dividends - Preferred
Dividend Requirement) * 100
Worldscoop
Tang
Tangible assets to total assets ratio
Worldscoop
Size
The log of the firm’s total asset.
Worldscoop
Age
Age of the company since incorporation
Annual report
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options. Among ownership structure variables, average ownership concentration of the three
largest shareholders is 68,35% with a maximum of 99,99%. The results of this variable shows
that ownership structure in our sample is concentrated. In addition, majority managerial
ownership, institutional ownership, family ownership and foreign ownership are observable
respectively at 13.15%, 16.55%, 20.80% and 4.95 %.
Table 3. Descriptive statistics
Notes: Obs. = Obesevations; Min. = Minimum; Max. = Maximum; Std. Dev. = Standard
Deviation;
- Correlation matrix
A possible strategy to detect multicollinearity is to use Spearman correlation analysis. Tables 4
Variables
Obs
Min
Max
Mean
Median
Std.Dev
AUR
2000
0
3.2729
0.9654
0.9015
0.5194
Ope_Exp
2000
0.0022
5.3054
0.9668
0.9317
0.9668
Adm_Exp
2000
0
3.7465
0.3432
0.2672
0.2968
Bloc
2000
5.2
99.99
68.35
76.06
28.47
B_Size
2000
3
23
8.983
8
4.259
B_Ind
2000
0
0.9411
0.345
0.333
0.236
Debt
2000
0
92.77
18.09
16.07
16.07
Div
2000
0
100
25.76
21.56
25.74
tang
2000
0
0.796
0.235
0.205
0.177
Size
2000
10.25
26.08
20.37
19.97
2.447
Age
2000
1
193
46.05
31
41.83
Variables
Modality
Frequency
Percentage
Over_Invest
1: Tobin’s Q is below sector average and free cash flow is
positive.
847
42.35
0: otherwise
1,153
57.65
Man_Own
1: managerial shareholding is more than 50% of the firm
263
13.15
0: otherwise
1737
86.85
Inst_Own
1: Institutional ownership owns more than 50%.
331
16.55
0: otherwise
1,669
83.45
Fam_Own
1: Family ownership is more than 50%.
416
20.80
0: otherwise
1,584
79.20
For _Own
1: Foreign ownership is more than 50%.
99
4.95
0: otherwise
1,901
95.05
Audit
1: the auditor is Big Four
1,504
75.20
0: otherwise
496
24.80
Option
1: CEO compensation structure has stock options
938
46.90
0 : otherwise
1,062
53.10
Notes: Obs. = Observation; Min. = Minimum; Max.= Maximum ; Std. Dev. = Standard Deviation;
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indicate that the correlation coefficients between explanatory variables are generally below
0.80, Gujarati (2003). The highest coefficient is 0.772, representing the correlation between the
board size and firm size. In addition, the results of the correlation analysis show that tangibility
are not significantly correlated with the percentage of shares owned by the three largest
shareholders. Moreover, there is no significant relationship between managerial owners and
Institutional ownership, firm debt, dividend and the firm age respectively. Also, we find that
there is no significant relationship between Institutional ownership and Big Four audit.
Table 4. Correlation matrix
1
2
3
4
5
6
7
8
9
10
11
12
13
14
1
1
2
0.267***
1
3
-0.118***
-0.033
1
4
0.194***
0.372***
-0.122***
1
5
-0.182***
-0.088***
0.320***
-0.099***
1
6
-0.280***
-0.260***
0.228***
-0.240***
0.205***
1
7
-0.224***
-0.179***
0.263***
-0.063***
0.201***
0.311***
1
8
-0.144***
-0.071***
0.012
-0.068***
0.067***
0.275***
0.184***
1
9
0.119***
0.005
0.086***
-0.129***
-0.031
0.146***
-0.012
0.101***
1
10
-0.124***
0.018
0.064***
-0.048**
0.074***
0.277***
0.094***
0.076***
0.070***
1
11
-0.191***
-0.199***
0.225***
-0.158***
0.215***
0.431***
0.361***
0.233***
-0.060***
0.068***
1
12
0.002
-0.078***
0.037*
0.019
0.096***
0.340***
0.132***
0.139***
0.349***
0.139***
-0.067***
1
13
-0.239***
-0.243***
0.295***
-0.231***
0.205***
0.772***
0.418***
0.350***
0.209***
0.316***
0.510***
0.335***
1
14
-0.069***
0.014
0.141***
0.106***
0.113***
0.395***
0.290***
0.120***
0.158***
0.205***
0.066***
0.342***
0.44
1
This table shows the correlation matrixes of research variables. *, **, and *** indicate
significance at the 10%, 5%, and 1% levels respectively. 1 is the percentage of shares owned by
the three largest shareholders. 2 is a dummy variable that takes1 if managerial ownership is
more than 50%, zero otherwise. 3 is a dummy variable that takes1 if Institutional ownership is
more than 50%, zero otherwise. 4 is a dummy variable that takes1 if Family ownership is more
than 50%, zero otherwise. 5 is a dummy variable that takes1 if foreign ownership is more than
50%, zero otherwise. 6 is the number of directors on the board. 7 present the ratio of the
number of independent outside directors to the total number of directors on the board. 8 present
a dummy variable that takes 1if the auditor is Big Four, zero otherwise. 9 present total debt to
total assets ratio. 10 is calculated as follows: Common Dividends (Cash)/ (Net Income before
Preferred Dividends - Preferred Dividend Requirement) * 100. 11 is a dummy variable that
takes1 if CEO compensation structure has stock options, zero otherwise. 12 present the
tangible assets to total assets ratio. 13 is the log of the firm‟s total assets. 14 is age of the
company since incorporation.
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5. Results and Discussion
In order to assess correlation between agency costs and corporate governance, we will interpret
the significance of each variable in the fourth regressions. Table 5 shows the results of our
regressions. This finding indicates that ownership concentration seems to play an important
role in mitigating administrative expenses by influencing managerial decisions, which is
consistent with Jensen and Meckling, (1976). In addition, ownership concentration seems to
affect investment decisions, precisely because of the relationship between ownership structure
and agency problems, which is consistent with Pindado and de la Torre (2007). These authors
found that ownership concentration reduces free cash flow available for discretionary expenses
and this by imposing, for example, greater financial discipline.
Analyzing the identity of majority shareholders of our sample, we found that managerial
ownership contribute to resolving agency conflicts, only at the level of reducing operational
expenses. However, they are a source of conflict like administrative expenses. Indeed, when
CEO have a majority shareholder, excessive spending on perks will be most important. This
result corroborates that of Charreaux (1991) who found that beyond 50%, management would
work be at the expense of shareholders „interests.
Our results also indicate that higher institutional ownership has no significant impact on the
efficient allocation of assets, operational expenses as well as administrative expenditure, which
is consistent with Doukas et al. (2000) and Singh and Davidson (2003). However, these
majority shareholders play a key role in mitigating agency problems related to overinvestment
risk because they can monitor management at lower costs as they have greater expertise and
resources. They may also vote against proposals sponsored by the manager by putting forward
their own measures or expressing their displeasure by selling their shares, "voting with their
feet", Parrino et al. (2003) and Larcker and Tayan (2011).
The results also show that family ownership increases agency costs of equity, which is
consistent with Morck and Yeung (2003) who argue that managers may act for the controlling
family by using of pyramidal groups to separate ownership from control as well as the
entrenchment of controlling families.
We see that the coefficients of foreign ownership are not significant in all four models, which is
consistent with the idea that the governance-improving role of foreign ownership is relatively
limited. This result is not consistent with Grossman and Hart, (1988) and Chen et al (2013)
which found a negative relationship between the higher level of foreign ownership and agency
cost of equity. In addition, we can notice that French privatized firms in our sample are audited
by the Big 4. Therefore, foreign shareholders delegate their role of monitoring to reputable
auditors that enhance firm transparency.
Contrary to the postulation of agency theory, this study argues that board size has a negative
effect on the efficient allocation of assets. Knowing that the average Board size in our sample is
around 8 or 9 members, a relatively high number, it seems that small boards are managed better
in terms of coordinating the views of its members, thereby reducing agency conflicts,
accelerating the decision-making process and lessening abusive behavior. This result confirms
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that of Jensen (1993), who predicted that a large board with7 and 8 members is less likely to
work effectively and therefore easier to be controlled by the CEO.
In addition, Florackis and Ozkan (2004) found that the larger the Board, the higher will be
agency costs. This is due to ineffective communication and bad decisions when increasing
board size beyond an optimal required level, John and Senbet (1998). Although French law
requires a detailed communication of companies about director independence criteria, it turns
out that board independence is not an efficient mechanism to manage assets as well as
discretionary administrative expenditures. Moreover, independent directors in France follow
specific profiles: president of retirement, officials, academics... etc. Most of them accessed
their positions through personal relationships or because they belong to the corporate network.
Therefore, this puts some doubt on their independent profiles. This result confirms the
conclusions of Brealey et al. (2014), who found that many board members may be
long-standing friends of the CEO may be indebted to the CEO for help or advice. Therefore,
the effectiveness of independent directors will be negligible. Similarly, we found that a big4
audit Committee helps mitigate over-investment risk, though it tends to reduce the
effectiveness of allocating assets. This result confirms that of Piot (2010) who found that audit
quality in the French context seems a valuable monitoring device that may improve
debtholders protection, enhance reliability of accounting numbers when risk of transferring
wealth at the expense of debtholders is significant. Although the use of debt as a financing tool
can reduce agency costs, it can also be a source of conflicts.
Managers often dispose of a high proportion of their wealth, depending on firm success.
Moreover, the results suggest that debt significantly and negatively relates to assets investment
rates. This result indicates that creditors feel less the need to monitor executive‟s performance
or to question their strategic decisions. As a result, they tend to rely more on shareholders to
monitor and control the management team. However, the roles of creditors as well as dividends
distribution are essential to control administrative expenses. In particular, bankers monitoring
allows the company to invest cash flow in investments rather than leave managers to waste
them in travel costs, advertising and marketing costs, salaries... etc.
Similarly, we confirm the free cash flow theory, a sound dividends distribution policy allows
for reducing the misuse of resources, which explains its negative impact on over-investment
risk. In other words, investors may ask for higher dividends or a stock repurchase not because
these are valuable in themselves, but because they encourage a more careful, value-oriented
investment policy.
We can add that forcing a firm to commit itself to pay dividends provides an alternative way of
forcing managers to be disciplined when selecting investment projects reducing the cash that is
available for discretionary uses. Opportunistic behavior of managers increases with stock
options. Referring Berk and Demarzo (2014), the managers of French companies manipulate
the "timing" of information disclosure in order to maximize stock options value, which
intensifies agency costs associated with firm expenditures, Singh and Davidson (2003).
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271
On the other hand, we found that stock options affect negatively overinvestment. This result
indicates that this incentive plan may also be tempted to defer valuable investment projects if
the projects would generate short-term earnings.
As for the control variables, we found several significant relationships in line with previous
agency cost studies. First, we report that tangible assets reduce administrative expenses and
overinvestment risk which is consistent with Ross et al.(2015) who argue that tangible assets
like buildings and equipments cannot be converted to cash in normal business activity (they are,
of course, used by the business to generate cash),reducing thus agency costs. We also found
that the coefficient for firm size is negative and significantly related to return on assets. This
result suggests that agency costs are higher for large firms.
Table 5. Regression results
Prais-Winsten regression, Correlated panels corrected standard errors (PCSEs)
Variables
AUR
Ope_Exp
Adm_Exp
Over_invest
Coef
Coef
Coef
Coef
Bloc
0.00014
0.00014
-0.00049***
-0.00097*
Man_Own
0.04564
-0.10189***
0.06476**
0.07201
Inst_Own
-0.02302
0.03183
-0.01198
-0.10744**
Fam_Own
-0.07237***
0.15048***
-0.03442
0.11922***
For_Own
0.00841
0.03826
0.01567
0.06096
B_Size
-0.00962***
0.00304
0.00190
0.00714*
B_Ind
-0.18481***
-0.01579
0.05256*
0.09579
Audit
-0.07488**
0.03858
-0.01244
-0.06965**
Debt
-0.00275***
-0.00034
-0.00045*
0.00001
Div
0.00043
-0.00021
-0.00026**
-0.00117**
Option
-0.00510
0.11591**
0.01083
-0.07447**
Tang
0.09229
0.20636**
-0.17260***
-0.61197***
Size
-0.07051***
-0.04553***
-0.04290***
0.03043***
Age
0.03419*
-0.14811***
0.01362
0.05562**
Constante
2.49405
2.24995
1.22490
-0.20000
R-squared
0.6778
0.5320
0.3582
0.1566
Prob> chi2
0.0000
0.0000
0.0000
0.0000
Observations
2000
2000
2000
2000
Note: bloc is the percentage of shares owned by the three largest shareholders. Man_Own is a
dummy variable that takes1 if managerial ownership is more than 50%, zero otherwise.
Inst_Own is a dummy variable that takes1 if Institutional ownership is more than 50%, zero
otherwise. Fam_Own is a dummy variable that takes1 if Family ownership is more than 50%,
zero otherwise. For_Own is a dummy variable that takes1 if foreign ownership is more than
50%, zero otherwise. B_Size is the number of directors on the board. B_Ind is the ratio of the
number of independent outside directors to the total number of directors on the board. Audit is
a dummy variable that takes 1if the auditor is Big Four, zero otherwise. Debt is total debt to
total assets ratio. Div is calculated as follows: Common Dividends (Cash)/ (Net Income before
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272
Preferred Dividends - Preferred Dividend Requirement) * 100. Option is a dummy variable
that takes1 if CEO compensation structure has stock options, zero otherwise. Tang is tangible
assets to total assets ratio. Size is the log of the firm‟s total assets. Age is age of the company
since incorporation. *** Indicate significance at the 1% level. ** Indicate significance at the
5% level. * Indicate significance at the 10% level.
6. Concluding Remarks and Future Research
Various corporate governance mechanisms are proposed to solve problems resulting from
conflicts of interest between management's personal interests and the goal of maximizing
shareholder wealth. However, the effectiveness of these disciplinary mechanisms is also being
questioned in the presence of opportunistic managerial behavior. Consequently, it is important
to clarify theoretical and empirical findings regarding the role of governance mechanisms as a
means of reducing principle-agent conflicts. Additionally, this study was an opportunity to
verify if French companies have adopted, in a disputable manner, the very highest standards of
corporate governance. In other words, we attempt to validate if the corporate governance
principles and recommendations was effective for resolving agency problems.
The French corporate governance system and institutional environment formed the starting
point of our analysis. Then, we had reviewed the main previous and recent empirical literature,
which studied the impact of the main internal governance mechanisms on agency costs.
Examining a sample of 125 companies, our main conclusion is that the identity of controlling
shareholders plays an important role in managing agency problems. They have an interest in
providing management incentives to maximize shareholder value. However, only majority
shareholders, who have a significant shore of the company, have enough money at stake and
enough power to be motivated to actively monitor managers and attempt to influence their
decisions. In contrast, we found that these shareholders themselves are not homogenous
because they do not have a single common investment horizon. Investors with a long-term
investment horizon could tolerate significant fluctuations in quarterly results and share price
when they believe that top-executive decisions are made to achieve a higher profitability level.
On the other hand, investors with a short-term investment horizon prefer short-term profit
maximization. In the same line of thinking, the results indicate that ownership concentration is
a disciplinary mechanism to control managerial opportunism.
Examining their corporate governance practices and reality, French firms are well positioned
with regard to international standards. Quality of their financial information has been enriched
in a satisfying manner. Similarly, this country does not comply with the highest governance
standards when it comes to the board of directors. Some progress is to be made to level with
Europe and North America. For the latter, the standards are that the manager in limited to2
mandates in external companies. In addition, most of independent directors in France accessed
their positions through personal relationships or because they belong to the corporate network.
Therefore, this questions their independent profiles. In fact, the latter has no incentives to
report on capital agency costs. Other internal governance mechanisms have proved their
inefficiency in controlling managerial opportunism in terms of in reducing overinvestment risk,
like audit quality, dividend policy and stock options. Future research in other emerging
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contexts would help to consolidate and refine our conclusions. In Particular, a comparative
research based on corporate governance models is needed.
The study has produced some interesting results and one avenue for future research by studying
opportunities for interaction (complementarities or substitutability) between governance
mechanisms and disciplinary mechanisms in explaining agency plans. We can also use the
"Corporate Governance Score" by identifying the level of governance (low, medium, and high)
and which gives us an idea of the internal governance mechanisms used by the company, and
more specifically of their application.
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Notes
Note 1. French Association of Private Sector Companies. http://www.afep.com/
Note 2. The Movement of French Enterprises. http://www.medef.com/en/
Note 3. We have considered institutional investors, banks, investment companies, insurance
companies and social security funds.
Note 4. The term “direct agency” costs come in two forms. The frst type is a corporate
expense that benefits management but costs the stockholders. The second type is an expense
that arises from the need to monitor management actions, Ross et al (2015).
Note 5. The asset turnover ratio can also capture (to some extent) the agency cost of debt.
For example, the sales ratio provides a good signal to the lender about how effectively the
borrower will employ his assets and, therefore, affect the cost of capital.
Note 6. Operational expenses exclude the costs of goods sold, interest costs, leasing, hiring
costs, depreciation and bad debts.
Note 7. Administration fees and other costs are non-production costs. These include post,
Telegraph and phone costs, transport costs and travel cost, salaries, wages and other benefits,
the depreciation charges. Sales and distribution costs are also the non-production costs, but
they directly relate to generation of revenue from saleable products.
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