Impact of corporate governance mechanisms on the cost of equity capital in emerging markets

• Published date: 01 May 2021
• Author: Saad Faysal,Mahdi Salehi,Mahdi Moradi
• Date: 01 May 2021
• DOI: http://doi.org/10.1002/pa.2166

ACADEMIC PAPER

Impact of corporate governance mechanisms on the cost of

equity capital in emerging markets

Saad Faysal | Mahdi Salehi | Mahdi Moradi

Economics and Administrative Sciences,

Ferdowsi University of Mashhad,

Mashhad, Iran

Correspondence

Mahdi Salehi, Economics and Administrative

Sciences, Ferdowsi University of Mashhad,

Mashhad, Iran.

Email: mehdi.salehi@um.ac.ir

The purpose of this study is to analyze the effects of corporate governance mecha-

nisms on the cost of equity (COE) of Iranian and Iraqi nonfinancial companies listed

in the Iran-Iraq Stock Exchange. In order to achieve the purpose of the study all listed

companies on the Iran-Iraq Stock Exchange, was considered as population of the

study during the period of 2012–2017 (137 Iranian listed companies and 34 Iraqi

listed companies). In order to test the relationship between variables, the researchers

used a set of statistics to estimate the multiple regression model appropriate to the

study. Our results indicate a significant positive role for the board size and CEO ten-

ure in reducing the COE. Finally, our results reveal a positive role in audit quality in

reducing the COE in the Iranian context.

1|INTRODUCTION

Having a well-established corporate governance program is one of

the ways that companies can take advantage of globalization and

invest in stocks around the world. This may attract long-term

stocks with low cost of equity (COE) capital. Following proper cor-

porate governance principles and practices will increase investor

confidence and reduce the COE and strengthen capital markets

(Salehi & Salami, 2020). If investors are unsure about the level of

disclosure, the capital will be transferred elsewhere. Also, if the

country does not adhere to accounting standards, it will be directed

to foreign capital flow, resulting in numerous economic conse-

quences for all companies and economic organization of the cou n-

try(Davis&Disney,1995).Thisissupportedthatinvestors

worldwide are willing to accept lower returns on investment in

companies with effective corporate governance. In another con-

text, Beasley (1996) explains that corporate governance mecha-

nisms encompass a wide range of measures to monitor the

opportunistic behavior of managers (John & Senbet, 1998; Salehi,

Jamalikazemini, & Farhangdoust, 2018). Corporate governance reg-

ulates the relationship between owners and managers through

supervision and control to reduce managers' opportunistic behavior

in corporate management (Roberts, 2005). Corporate governance

mechanisms also provide a variety of methods to control the

opportunistic behavior of executives (Boshkoska, 2015). These

results are in line with the findings of Kungu and Munyua (2016)

which show that implementing good corporate governance mea-

sures reduces agency costs and thus improves performance. The

cost of capital played an important role in the investment decisions

and operations of the company and influenced the company's

behavior in dealing with investors. Therefore, the relationship

between the quality of corporate governance and the cost of capi-

tal is important to determine the security of investing money in

companies that are committed to corporate governance (Gul,

Rashid,&Muhammad,2016).Theissue of capital spending has

been of great importance for centuries and throughout the world

as one of the key issues and the backbone of companies for sus-

taining cash flow, growth, and access to lower-cost investment.

TheCOEisthekeyplayerinthelifetimeofcompaniesandtheir

continuity. Ashbaugh, Collins, and LaFond (2004) argues that the

cost of capital is one of the most important elements in attracting

internal and external investment of companies and serves as a

meeting point between the investor and the company, that the real

goal of corporate governance is to minim ize the agency problem,

this can contribute to lower risks, regulate management responsi-

bilities and improve performance and control the behavior of mis-

managing in the confiscation of shareholders' wealth. There are

several ways to secure entity credit. Byun, Kwak, and Hwang (2008)

arguethatoneofthemostimportant advantages of a corporate

governance structure is to give companies the confidence and

credit that the company can obtain equity capital in the future, at a

lower COE. Khan (2016) argues that whatever agency problems or

Received: 8 April 2020 Revised: 15 April 2020 Accepted: 25 April 2020

DOI: 10.1002/pa.2166

J Public Affairs. 2021;21:e2166. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons, Ltd 1of11

https://doi.org/10.1002/pa.2166