BOARD EFFECTIVENESS AND COMPANY PERFORMANCE: ASSESSING THE MEDIATING ROLE OF CAPITAL STRUCTURE DECISIONS

ABSTRACTThis study examines the mediation effect of capital structure decisions on the relationship between board process and company performance in Malaysia. The study uses two types of data; a questionnaire survey of Malaysian directors and the companies' annual report. Based on 175 public listed companies, the study finds that effective independent directors and boards who monitor company risks vigorously are more likely to monitor management from adopting excessive leverage, which results in positive company performance. Overall findings are expected to serve as a basis for more effective corporate governance policies and practices in Malaysia in ensuring the sustainability of the listed companies.Keywords: Board Process, Capital Structure, Company Performance, Independent Directors, Risk Oversight1. INTRODUCTIONThe board of directors is one of the prominent corporate governance mechanisms as they are expected to monitor and protect the interests of shareholders. Even though previous corporate governance literatures recognize the importance of board of directors (Kula, 2005; Wan & Ong, 2005), the studies on the directors' behavior and practices in conducting their roles are still lacking (Hasnah & Hasnah, 2009). Most of previous studies focus on the direct effect of board structure, composition and characteristics on company performance or leverage (Noriza, 2010; Rohana, Halimi & Erlane, 2009; Yu, Rwegasira & Bilderbeek, 2002). Such board attributes alone does not reflect the quality of the board, therefore, study on board process is highly demanded. Board process refers to the approach taken by the directors in discharging their duties and the reflection of board's decision making activities (Macus, 2008). From the theoretical perspectives, the board monitoring function is very important; it is derived from agency theory (Jensen & Meckling, 1976). As decision making falls to top management, the board should vigorously monitor the decision making process and company performance as a whole (Jensen & Meckling, 1976). Johnson, Daily and Ellstrand (1996) point out that board process influences company performance through strategic decisions. Decision on capital structure is the essential part of strategies implementation (David, 2008). The cases of Lehman Brothers and Bear Stearns in the United States and Linear Corporation Berhad in Malaysia have shown the evidences that highly leverage capital structure lead to company failure. Therefore, as proposed by Johnson et al. (1996) and David (2008) this study will incorporate leverage as mediator variable. The proposal is also similar to the recommendation by La Rocca (2007) where the author points out that board effectiveness, capital structure and company value should be incorporated in a study. Based on above arguments, the main objective of this study is to determine the extent to which capital structure decision mediates the relationship between board process and company performance.In this study, four prominent attributes represent the board process namely board's risk oversight, Chief Executive Officer (CEO) performance evaluation, performance of independent directors and directors' accessibility to information. In analyzing whether company leverage mediates the relationship between board process and company performance, the study takes into consideration three conditions (Baron & Kenny, 1986). The study presumes a significant direct relationship between (1) board process and capital structure decision and (2) board process and company performance. Then in the third (3) step, capital structure decision is treated as the intervening variable between board process and company performance. Figure 1 illustrates the relationship between board process, capital structure decision and company performance.The paper is organized as follows. In the following section, the predictions on the influence of board process on capital structure decisions and company performance are presented. …