Capital Structure And The Mechanism Of Corporate Governance

The basic characteristic of modern corporate system is the separation of ownership and control, which is based on the theoretical foundation of Fisher separation theorem. The separation of these two rights has led to the principle-agent relationship between shareholders and managers, thus resulting in agency problem and costs. Corporate governance is the mechanism in place to reduce the agency costs caused by the separation of two rights and to protect shareholders to gain from investments. The purpose of corporate governance is to pursue the maximization of shareholder value, while the other stakeholders should be protected by contracts and laws. Corporate governance includes incentive and control. Doing research on the relationship between capital structure and the mechanism of corporate governance is to further scrutinize mechanism of debt monitoring, one of the mechanism of external control of corporate governance.The MM theorem without tax is based on Arrow-Debreu general equilibrium framework, the new classical one. Although incorporating elements like the corporate income tax, bankruptcy costs and individual income tax, further theory development has failed to breakthrough the new classical theory. However, when incorporating the agency problem caused by separation of ownership and control into the theoretical research, and considering imperfect contract, information asymmetry and agency costs, corporate governance is combined into the discussion of capital structure. Thus, doing research on capital structure and the mechanism of corporate governance has become the modification and development of new classical capital structure theory.The information asymmetry includes ex-post and ex-ante ones. The ex-post information asymmetry is likely to trigger moral hazard. Managers will not work hard as suggested by the social optimal level, because the shareholders can't observe and monitor their working. Managers can also utilize their control over free cash flow to overinvest and expand inefficiently for entrenchment, or to perquisite consumption. Increasing the ratio of debt in capital structure helps reduce the agency cost caused by moral hazard, so as to increase corporate value. In ex-ante information asymmetry, adverse selection usually causes inefficiency in corporate financial market, likely leading to market breakdown and cross-subsidization, leading to under-or over-investment. The capital structure, as an information signal used by internal managers, can efficiently transfer inside information, influence the investment incentives of external investors, reduce the agency cost caused by adverse selection, and increase the financing efficiency and firm value. The optimal capital structure should consider the comprehensive effect of debt to reduce both moral hazard and adverse selection, so that the addition of both its marginal tax shield and its reduction effect on the marginal agency costs of equity, is equal to the marginal bankruptcy costs of debt.Compared with developed countries like Europe and U.S.A., capital structure of the listed companies in our country has shown obvious preference to equity financing. The elements which affect capital structure decision making of the listed companies in our country include both macro and micro ones. Macro elements mainly include economic growth, inflation, status of stock market and corporate bond market, and industrial elements. The result of empirical analysis suggests that the average leverage of the listed companies in our country is positively correlated with the economic growth rate and development of corporate bond market, and negatively correlated with inflation and securitization. Micro elements include firm size, earnings, non-circulating equity, equity concentration, behavior of managers, and financing cost of equity. The result of empirical analysis shows average leverage of the listed companies in our country is positively correlated with the firm size, percentage of circulating equity, and number of independent director, and negatively correlated with earnings and Z index, and statistically unrelated with Herfindahl-Hirschman index of top five shareholders, the largest shareholder's share percentage, and holdings of top managers. Excessive reliance on equity financing will have negative impact on the corporate governance on listed companies of our country. The result of empirical analysis points out that the turnover of total asset is positively correlated with leverage, implying the negative correlation between the quality of corporate governance and equity financing preference. Excessive reliance on equity financing will increase the agency cost, reduce the quality of corporate governance and harm the firm value.How to optimize the capital structure and the mechanism of corporate governance? It is necessary to further regulate and improve capital market, develop corporate bond market, combine mechanism of incentive and control to reduce the manager's inclination to opportunism, enhance the independent director system and establish oligopoly equity structure with large shareholders balancing with each other, and reinforce the protection to investors especially to middle and small ones.