This paper contributes to the corporate administration literature by analyzing the consequence of corporate administration features on funding determinations in Saudi Arabian listed companies. In peculiar, we examine the consequence of board size ; ownership concentration and corporate administration coverage on the debt-to-equity ratio. We use a multiple arrested development theoretical account to analyze how corporate administration variables affect the extent to which Saudi Arabian companies use debt to finance their activities.
We use a sample of 37 companies listed in Saudi Stock Market in January 2006 which is based on a recent paper by Hussainey and Al-Nodel ( 2008 ) who collected their sample from Saudi listed companies ‘ web sites between October 2005 and January 2006 stand foring a entire figure of 77 companies. This helps us to concentrate on a group of houses that report corporate administration information on their web sites
After commanding for companies ‘ profitableness and their growing chances, we find that both board size and ownership concentration are positively associated with debt-to-equity ratio. The findings seem to propose that directors are likely to take higher fiscal purchase when they have stronger corporate administration ( big figure of managers on the board and higher ownership concentration ) . However, the empirical consequences of the relationships are statistically undistinguished in the instance of corporate administration coverage. This suggests that house ‘s asymmetric information is non an of import driver of the funding determination of Saudi Arabian companies. This might be due to the nature of the Saudi concern environment.
Capital construction determination is a good established portion of the accounting and finance research related to determiners of corporate capital construction. Modigliani and Miller ( 1958 ) is the first to analyze this country of research. They find that capital construction determination is unrelated to tauten value. They besides relax the prefect market premises and see corporate revenue enhancement into their theoretical accounts ( Miller and Modigliani, 1963 ) . Consequently, they find that house value will be enhanced if the degree of debt additions. They explain their findings by the fact that involvement rate is a revenue enhancement deductible and consequently companies would bask debt revenue enhancement shield when funding their activities by long-run debt. However, Miller and Modigliani ( 1963 ) Don non taken into history the bankruptcy related costs. A natural country of widening these lines of research is to research other drivers of corporate capital construction determinations.
Previous surveies offer grounds that corporate administration variables affect houses ‘ capital construction determinations ( Wen et al. , 2002 ; Du and Dia, 2005 ; La Rocca, 2007 ; Driffield et al. , 2007 ; Al-Najjar and Hussainey, 2009a, 2009b ) . However, there are a really limited figure of surveies that have examined determiners of capital construction in developing states and even fewer such surveies may be found in the Middle Eastern states. To the best of our cognition, no survey yet has examined the influence of corporate administration on capital construction determination in Saudi Arabia or Middle Eastern states. Consequently, this paper is the first to analyze the possible corporate administration factors that might drive Saudi Arabian houses to utilize debt as the chief beginning of finance.
This paper is besides motivated by the fact that SACMA issued a counsel in 2006 that recommends all listed companies to unwrap corporate administration information to the populace. Therefore, it would be worthwhile analyzing the attitude of companies to volunteer study corporate administration instead than being enforced to make so.
The paper returns as follows. Sections 2 and 3 reappraisal prior research on the determiners of capital construction and develop the research hypotheses. Section 4 discusses the research method. Section 5 is the information description. The chief arrested development consequences are presented in Section 6. Finally, Section 7 concludes and suggests countries for future research.
2. Literature reappraisal
For puting the findings of this survey within its context, every bit good as other environments with similar features this subdivision provides a general description of the environment of the Saudi concern patterns.
Several environmental factors affect Saudi concern pattern, this subdivision, nevertheless, will summaries some of the most of import environmental factors, as suggested by the literature such as the political, economical, and societal systems and the 1965 Company Law that regulates the pattern of Saudi concerns and the counsel of corporate administration issued by SACMA in 2006.
As similar to most states in the Middle Eastern part, the early phase of the political, economic and societal development in the state makes the environment of the Saudi audit pattern significantly different from that in developed states.
The political system of Saudi Arabia is a monarchy, headed by the King. Within the political system, there are three legislative organic structures, which have the authorization to originate and/or O.K. policies, ordinance or regulations: the Council of Ministers, the Consultative Council, and assorted single Ministries. There are assorted groups within the political system influence major policy issues and the development of new ordinances. The chief groups are the royal household, Islamic bookmans, province functionaries, broad elites, faculty members, tribal leaders and business communities ; all of whom have different involvements and different powers depending on the importance of the issue to its involvements and personal businesss ( Al-Amari, 1989 ; Al-Rumaihi, 1997 ; Aba-Alkhail, 2001 ; Economist Intelligence Unit, 2003 ; Al-Nodel 2004 ) . The Basic Law of Government which was introduced in 1992 is considered to be the fundamental law of the KSA ( Economist Intelligence Unit, 2003 ) .
As an Islamic state, the legal system of Saudi Arabia is derived from Islamic jurisprudence ( Shariah ; Alqur’an Alkareem and Sunna Alsharifah ) , and coded Torahs for a figure of specific Fieldss, such as commercialism, revenue enhancement and labor. Al-Amari ( 1989 ) reported that Islamic jurisprudence, nevertheless, prevails in legal differences.
Saudi society is to a great extent influenced by its Arabic heritage and Islamic values ( Al-Rumaihi, 1997 ; Aba-Alkhail, 2001 ; Al-Nodel 2004 ) . All Saudis are Muslim, and the Arab Peninsula is the place of birth of Islam. Al-Rumaihi ( 1997 ) described Saudi society as characterised by the impact of the personality and power of peculiar persons, the function of household and friend relationships over ordinances, privilege given to personal relationships over undertakings, and the being of a high degree of secretiveness.
The economic system of Saudi Arabia is an oil-based economic system and authorities exercisings strong controls over major economic activities. It possesses 25 % of the universe ‘s proved crude oil militias, ranks as the largest exporter of crude oil, and plays a prima function in OPEC. Worldwide oil monetary values and production volumes strongly affect Saudi economic system. Since the find of oil in 1938, oil gross represents the biggest part to the economic system. In 1990s, it accounted for around 35 % of nominal GDP, approximately 75 % of authorities grosss, and 85 % of export grosss ( Economist Intelligence Unit, 2003 ) . Table 2 nowadayss the state ‘s budgetary grosss, outgos and net excess or ( shortage ) for the last three old ages.
Insert Table 1 here
Noticeable characteristics of the current pattern of Saudi companies are the domination of household concerns, the deep engagement of the authorities in the private sector, and the being of a figure of foreign-owned and controlled companies based on joint venture understandings with domestic companies.
The domination of household concerns type in Saudi Arabia is argued by Al-Nodel ( 2004 ) . He explained that joint-stock companies represent merely 1.14 % of the entire figure, and history for less than 40 % of the entire capital of the registered concerns.
The being of a figure of foreign-owned and controlled companies based on joint venture understandings with domestic companies and the engagement of authorities in concerns represents another important characteristic of the Saudi private sector ( Presley, 1984 ; Aba-Alkhail, 2001 ) .
The 1965 Company Law regulates the pattern of concerns in Saudi Arabia. It sets conditions for set uping concerns, describes the legal model for concern, and requires the publication of one-year fiscal statements audited by an independent party ( see besides Al-Rehaily, 1992 ; Aba-Alkhail, 2001 and Al-Nodel 2004 ) . Articles of the 1965 Company Law sets conditions for several facets of concerns such as legal models through which concern companies can be established, the enrollment demands, minimal capital to be maintained, figure of spouses, figure of managers, histories, the one-year audit of the histories, and so on. Shinawi and Crum ( 1971 ) asserted that the beginning of the 1965 Saudi Company Law goes back to the British Companies Act of 1948. The similarity between the 1965 Saudi Company Law and the UK Acts of the Apostless issued in 1948, 1967 and 1976 was besides reported by Kahlid ( 1983 ) .
The chief characteristics of the 1965 Company Law are the legal models of concerns and the coverage demands. It provides several legal models through which concern companies can be established such as general partnership, joint venture, joint-stock company, limited liability company, and concerted company[ 1 ].
The 1965 Company Law besides sets the coverage demands of concerns. It requires the issue of a balance sheet, a net income and loss history, and a study on the company ‘s operations and fiscal place every financial twelvemonth. It farther stipulates that all corporations, and limited liability companies must publish one-year fiscal statements audited by an independent hearer licensed to pattern by the Saudi Ministry of Commerce and Industry.
The stock market of Saudi Arabia is underdevelopment. In 1984, the Royal Decree No. 81230 was issued as an effort to officially modulate the stock exchange ( Abdeen and Dale, 1984 ; El-Sharkawy, 2006 ) . Under this Royal Decree, the Saudi Arabian Monetary Agency ( SAMA ) was given existent control over the stock exchange through national commercial Bankss.
The important alteration was in 2003 when the Saudi Arabian Capital Market Authority ( SACMA ) , which took duty from SAMA to oversight the exchange of Saudi stocks, was established ( Ramady, 2005 ) . This period observed important alterations with regard to the figure of listed companies or market value. Table ( 3 ) compares some cardinal Numberss of the Saudi stock market between 1996- 2005.
Insert Table 2 here
In 2006 SACMA intensifies its attempts to supply equity in the trading of the Saudi stocks. Among these attempts was the issue of the bill of exchange of corporate administration for listed companies in 2006. The bill of exchange provides recommendations of the standards for the best corporate administration pattern that should listed companies advocate. It has covered to some extent the chief five rules issued by the Organization for Economic Co-operation and Development ( OECD ) : the rights of stockholders, the just intervention of stockholders, the function of stakeholders in corporate administration, revelation and transparence, the duty of the board of managers.
Harmonizing to the recommendations of SACMA, listed companies are required to describe to SACMA about their conformity with the standards of corporate administration as issued by SACMA or grounds for uncompliance if any. The revelation contains, for illustration, the board of managers ‘ maps, duties, formation, commissions of board of managers ; audit commission ; Nomination and Remuneration Committee ; Meetings of the Board and Remuneration and Indemnification of Board Members[ 2 ].
Finally, SACMA asserted that the standards for the best corporate administration pattern largely constitutes the guiding rules for all listed companies unless any other ordinances, Torahs or regulations require such demand.
Although, corporate administration has been the topic for an extended research in developed states[ 3 ], limited research has been carried out to look into the issue of corporate administration in concern environment of developing states. Furthermore, those limited research surveies approach the issue whether to depict the province of corporate administration from an official position or from the position of what should the practical applications of its rules be.
For illustration, Al-Motairy ( 2003 ) explores the province of corporate administration patterns in Saudi Arabia. He concludes that there is a critical demand for ( 1 ) a reappraisal of these ordinances to reflect the current patterns of corporate administration, ( 2 ) the issue of counsel for best patterns for direction and fiscal matter in corporations and ( 3 ) the constitution of an administration to speed up the acceptance of best patterns of corporate administration.
Similarly, Fouzy ( 2003 ) evaluates the patterns of corporate administration ‘s rules in Egypt. He recognises the development in Egyptian official ordinances toward the application of best patterns of corporate administration. He so argues that these developments are non met plenty by Egyptian companies in their practical applications.
Another illustration is the survey which was carried out by Oyelere and Mohammed ( 2005 ) look intoing the patterns of corporate administration in Oman and how it is being communicated to stakeholders. They recommend enhanced ordinance and communicating for the Omani stock market to maintain gait with the international developments.
Finally, a research paper by the Centre for International Private Enterprise ( CIPE, 2003 ) examines the corporate administration pattern in four In-between Eastern states ( Egypt, Jordan, Morocco, and Lebanon ) . It finds that corporate administration pattern is approached otherwise by each state. This is depended on the edification of the fiscal market in each state. The research paper further provides several recommendations to better the application of the rules of corporate administration in the part as a whole.
In decision, research surveies that investigated the issue of corporate administration assert the importance of better ordinances of the corporate administration in the part in order to increase the public assurance in fiscal markets
3. Research hypotheses
Although the relationship between corporate administration and capital construction has been the topic for an extended research in developed states, limited research has been carried out to look into the issue in concern environment of developing states. In the subsequent paragraphs we formulate three research hypotheses.
Board size hypothesis
The association between board size and capital construction determinations have been good established in anterior accounting and finance research. In peculiar, Mehran ( 1992 ) , Berger et Al. ( 1997 ) , Wiwattanakantang ( 1999 ) , Wen et Al. ( 2002 ) , Du and Dia ( 2005 ) , Abor and Biekpe ( 2005 ) and Al-Najjar and Hussainey ( 2009a and 2009b ) examine the association between board size and corporate capital construction determination, but the consequences are assorted.
Mehran ( 1992 ) , Berger et Al. ( 1997 ) , and Abor and Biekpe ( 2005 ) happen a important negative association between the size of the board of managers and debt-to-equity ratios. However, Jensen ( 1986 ) finds a positive association between higher debt ratios and larger board size. Other research workers ( Wiwattanakantang, 1999 ; Wen et al. , 2002 ; Al-Najjar and Hussainey, 2009 ) find that there is no important association between board size and debt-to-equity ratios.
Given the above assorted consequences, we besides revisit this research country and analyze the association between board size and capital construction for Saudi Arabian companies. We set the following first research hypothesis for the impact of board size on capital construction:
H1: Ceteris paribus, there is a relationship between board size and debt-to-equity ratio.
Ownership concentration hypothesis
Ownership concentration is considered as one of the cardinal determiners of capital construction determination. Wiwattanakantang ( 1999 ) finds that managerial shareholdings have consistent positive influence on family-owned house purchase. In add-on, Al-Najjar and Hussainey ( 2009a ) find that insider ownership is positively and significantly associated with the debt-to-equity ratio. However, Al-Najjar and Hussainey ( 2009b ) did non happen the expected important consequences.
Given the above consequences are – to some extent – assorted, we besides revisit this research country and analyze the association between ownership concentration and capital construction for Saudi Arabian companies. We set the undermentioned 2nd research hypothesis for the impact of ownership concentration on capital construction:
H2: Ceteris paribus, there is a relationship between ownership concentration and debt-to-equity ratio.
Corporate administration coverage
A new and turning figure of surveies have investigated the association between asymmetric information and corporate determinations ( see Li and Zhao, 2006 for more inside informations ) . In a recent paper, Bharath et Al. ( 2009 ) use a fresh information dissymmetry index and analyze the extent to which information dissymmetry is a determiner of capital construction determinations. They found that information dissymmetry affects capital construction determinations of US companies. In peculiar, they found a important positive association between information dissymmetry and debt-to-equity ratio. In other words, their consequences suggest that houses will higher degrees of information asymmetric are more likely to utilize debt in financing their activities than equity.
Based on the above consequences, we explore the function of the information environment on capital construction determination in Saudi Arabian companies. We use a corporate administration voluntary revelation index as a step of a house ‘s information environment. Prior research finds that voluntary revelation is negatively related to asymmetric information. For illustration, Hussainey et Al. ( 2003 ) happen higher degrees of voluntary revelation cut down information dissymmetry between the house and investors and hence addition investors ‘ ability to better anticipate future net incomes. We set the undermentioned 3rd research hypothesis for the impact of corporate administration coverage on capital construction:
H3: Ceteris paribus, there is a negative relationship between corporate administration coverage and debt-to-equity ratio.
4. Model Development
In order to prove the above hypotheses, we regress debt-to-equity ratio on some corporate administration features and some control variables. The survey will look into the undermentioned theoretical account:
is defined as long term debt to equity ratio ; is the intercept. is the incline coefficient estimations of regressors. is the corporate administration variables ( and command variables ) for house I at clip T.
The dependant variable ( ) is defined as the long term debt to equity ratio.
We have three independent variables and two control variables. We identify three types of corporate administration variables:
( 1 ) Board size ( BOARD ) : This represents the figure of executive and non executive managers on the board.
( 2 ) Ownership concentration ( OWNERSHIP ) : This represents the entire per centum of the company ‘s portions that owned by proprietors.
( 3 ) Corporate administration coverage ( DISCLOSURE ) : This is calculated as the figure of sentences that include at least one corporate administration related information.
( 1 ) Profitableness ( PROF ) : we use return on entire assets as a step for houses ‘ profitableness.
( 2 ) Growth chance ( MB ) : we use portion monetary value to book value ratio as a step for house ‘s growing chance.
Our informations aggregation is based on a recent paper by Hussainey and Al-Nodel ( 2008 ) . This helps us to concentrate on a group of houses that report corporate administration information on their web sites. Hussainey and Al-Nodel ( 2008 ) collected their sample from Saudi listed companies ‘ web sites between October 2005 and January 2006. At that clip, the entire figure of companies listed in the Saudi Stock Market was 77 stand foring eight sectors: agribusiness, services, cement, industrial, Bankss, electrical, telecommunication and insurance. They used TADAWUL web site ( www.tdwl.net ) and Google website ( www.google.com ) to entree every company ‘s web site. They deleted some companies from their analysis for a figure of grounds. These include 11 houses without web sites ; one house with a website under building and one house with a restricted web site. This reduced their sample to 64 companies. We besides farther 27 houses because of losing corporate administration and accounting information. This leads to a sample of 37 listed houses for the current survey.
Datas on debt-to-equity ratio, Board size, ownership concentration, profitableness and price-to-book value ratio are collected from TADAWUL web site. Following Hussainey and Al-Nodel ( 2008 ) , we use the content analysis attack to mensurate the figure of sentences that contain corporate administration information. Consequently we use the corporate administration revelation index developed by Hussainey and Al-Nodel ( 2008 ) to analyze the content of every company ‘s web site.
6. Empirical Consequences
This subdivision discusses the descriptive analysis, the correlativity analysis and the empirical consequences.
Table 1 shows the descriptive analysis ( average, minimal, maximal and the standard divergence ) . It shows that on norm the figure of managers on board in Saudi Arabia companies is about 8, with a lower limit of 4 members and a upper limit of 11 members. Average ownership concentration is 35.6 and the average corporate administration revelation is 5 sentences with a lower limit of zero corporate administration sentence and a upper limit of 21 corporate administration sentences.
A wide scope of fluctuation in fiscal variables is besides apparent in our sample. The debt-to-equity ratio ranges from 0 to 97 with a mean of 24.52 and a standard divergence of 32.576. The return on entire assets ratio scopes from -37.3 to 71.74 with a mean of 8.8535 and a standard divergence of 13.81767. The portion monetary value to book value ratio ranges from 0 to 21 with a mean of 5.03 and a standard divergence of 5.336.
Insert table 3 here
Table 2 shows the correlativity analysis. The correlativity between each of the independent variables is non excessively high. The highest correlativity found between corporate administration revelation and portion monetary value to book value ratio ( MB ) is 43.5, which is acceptable. This confirms that no multicollinearity job exists between the independent variables.
Insert table 4 here
Table 3 shows our empirical consequences. It shows that the coefficient estimation on board size is positive important with a p-value of 0.059 ( see model 4 ) . This is consistent with Jensen ( 1986 ) who besides finds a positive association between higher debt ratios and larger board size. Our happening indicates that larger board size puts Saudi Arabian houses in a good place to finance their activities by utilizing debt. This is consistent with the fact that higher quality of corporate administration improves companies ‘ fiscal public presentation ( Bhagat and Bolton, 2008 ) and therefore leads increase the ability of the company to obtain debt. Liang and Zheng ( 2005 ) provide an account for this positive mark. They argue that boards with a big board size are more likely to hold a trouble in acquiring an understanding because of different and conflict sentiments and positions. Consequently, houses with big figure of managers on board might non take equity funding which requires high dealing cost to decide communicating and coordination quandary. In add-on, they argue that managers would take debt for financing their activities because this beginning of finance will non thin the equity of current stockholders and alter their current place. This leads us to accept hypothesis 1.
Table 3 besides shows that the coefficient estimation on ownership concentration is positive important with a p-value of 0.005 ( see model 4 ) . This consequence is consistent with Wiwattanakantang ( 1999 ) Al-Najjar and Hussainey ( 2009a ) . This indicates that when the entire per centum of the company ‘s portions is concentrated internally, directors will prefer to utilize debt to finance their companies ‘ activities. This is because – as mentioned in Liang and Zheng ( 2005 ) – debt will non thin the equity of current stockholders and alter their current place. This leads us to accept hypothesis 2.
Finally, corporate administration revelation as a placeholder for asymmetric information between directors and investors is expected to be negative and statistically important. However, Table 3 shows that the coefficient estimation of DISCLOSURE variable is positive, bespeaking that houses with higher degrees of corporate administration revelation ( less information dissymmetry ) has higher debt-to-equity ratio. This determination is statistically undistinguished and non consistent with anterior research. This leads us to reject hypothesis 3.
The purpose of this paper was to analyze the consequence of corporate administration mechanisms on capital construction for Saudi Arabian listed companies. Our consequences show that the corporate capital construction determinations in Saudi Arabia is driven by some of the same corporate administration determinates suggested in anterior research. Based on a sample of 37 Saudi Arabian listed companies, our consequences show that the figure of managers on boards and ownership concentration are the chief drivers of Saudi companies for capital construction determinations.
As mentioned in Hussainey and Al-Nodel ( 2008 ) , the chief restriction of the survey is that it did non cover the whole market so the sample may non be representative of the population of Saudi companies. This, nevertheless, is justified by the nature of the survey, which relied on the handiness of companies ‘ web sites. So companies that are non included in our survey are more likely to hold either no web site, with a website under building or the entree to the information in their web site is restricted. This is apparent by look intoing the type of companies, which are non included. We found that these companies are in general little and less likely to utilize the online coverage. Nevertheless, a survey with a big figure of companies is needed for future research.