The Effects of Corporate Governance, Voluntary Disclosures and Information Asymmetry on Agency Cost: A Moderated Mediation Examinatio

Abstract

In light of many financial scandals during the last four decades (e.g., Enron, Parmalat, and Crescent Standard Investment Bank Limited), companies are paying more attention to resolve management's opportunistic behaviors in the form of fund expropriation, empire building, and suboptimal investments. Managers are presumed to possess additional information on a firm’s current performance and future prospects, which leads to increase information asymmetry and agency costs. Therefore, the implementation of an appropriate system of corporate governance to reduce information asymmetry constrains agents from behaving opportunistically and, as a result, reduces agency costs. Moreover, effective voluntary disclosures play an additional role in monitoring managerial activities by providing more transparency and understanding to investors and creditors about the company. Based on these arguments, this study aims to investigate the fundamental role that information asymmetry plays as a mediator in the relationship between corporate governance and agency cost. The study further evaluates the role of voluntary disclosures in moderating the mediated relationship between corporate governance and agency cost through information asymmetry. The sample of the study is selected from the non-financial firms (listed on the Pakistan Stock Exchange) during the period from 2009 to 2015. The moderated mediation is applied using PROCESS Macro to construct bootstrap confidence intervals at the 95% level to estimate the model and a “simple slope analysis” to visualize the model. The direct relationship shows that despite increasing corporate governance mechanisms, the agency cost of overinvestment is rising. However, the indirect relationship suggests that the corporate governance mechanism promotes transparency by exerting pressure on management to produce information that investors and other stakeholders can use. This creates a monitoring channel that reduces information asymmetry, thus reducing the ability of management and majority shareholders to expropriate the firm’s resources, which mitigates the overinvestment of free cash flow. The positive effect of corporate governance on agency cost in the direct relationship becomes negative in the indirect relationship, xi contingent on increased voluntary disclosures by means of an additional controlling mechanism that mitigates the agency cost. Additionally, a high level (vs. low) of voluntary disclosure index and sub-indices are better able to negatively moderate the mediated relationship. The results support the agency cost hypothesis that states that managers and dominant shareholders make suboptimal investments when disclosure quality is reduced. Despite the efforts of academia, professionals, and regulatory bodies, the disclosure of value relevant information is limited. The insights provide implications for the Pakistan Institute of Corporate Governance to ensure the effective execution of the governance rules. Likewise, it is important to set voluntary reporting standards in response to calls for additional control devices (i.e., voluntary disclosures).