Capital Structure and Investment Behaviour of Malaysian Firms in the 1990s: a study of corporate governance before the crisis

This is an empirical study analysing the corporate finance and governance structure in Malaysia before and after the financial crisis of 1997, utilising the agency cost approach. The contribution of this paper is to link the corporate governance mechanism with the role of banks and corporate ownership structure peculiar to Malaysia, taking into account the institutional framework and historical background of the Malaysian financial system, such as government protection for the banking sector and the social dispersion of corporate ownership related to the Malay First policy. Based on data for 375 non–financial KLSE (Kuala Lumpur Stock Exchange) listed companies during fiscal years 1995–99, our analysis is organised into three parts. Characteristics of corporate finance in Malaysia in the 1990s using aggregated time–series data are outlined, followed by an examination of the determinants of capital structure via cross–sectional regressions in terms of dependency on banks and ethnic ownership structure, controlling ownership concentration, availability of internal funds, corporate size, industry effects, etc. We then estimate simple investment functions with panel data in order to examine the effects of debt financing on corporate investments before the crisis. Empirical results show the following. Firstly, the commitment of banks to finance corporate debt as well as lending obviously increased debt ratios. Secondly, increasing ownership by native Malays, both the direct and indirect holding of corporate shares, played no significant role in disciplining corporate management. However, ownership concentration mitigated conflict between managers and owners. Foreign ownership also contributed to a reduction in the agency cost of equity financing in financial liberalisation. Finally, high dependency on debt led to excessive corporate investment before the crisis. These results imply that the concentration of risks on the banking sector and social policy advocating the dispersion of corporate ownership weakened the corporate governance mechanism, thereby exacerbating the distress of Malaysia's corporate sector during the financial crisis.