Corporate governance, agency costs and investment appraisal: An assessment

Abstract

Undoubtedly, capital markets have an impact on investment appraisal decisions through interest rates (cost of capital) charged and debt covenants stipulated in debt contracts. However, the extent of influence of their interactions in shaping and determining a firm’s corporate governance policy, agency costs, investment decisions and firm value has been overlooked or not duly emphasised in the literature to date. This lack of interdisciplinary research in areas such as finance, accounting, capital markets and corporate governance may lead financial managers making wrong interpretation of the current empirical evidence. This may result into suboptimal decisions in capital budgeting decisions. There are various existing studies that have discussed the relation between corporate governance and one or two other business topics this paper is assessing. However, questions have persisted about the role capital markets’ interactions play in determining firm’s corporate governance, minimizing agency costs, long term investment decisions and firm value. The recent high profile global company collapses mainly due to poor corporate governance mechanisms have rekindled the interest in the role capital market interactions play in formulating firm’s corporate governance rules and policies and their impact on agency costs, investment appraisal decisions and firm value. This study intends to assess this issue and critically evaluates these related issues. The impact of multiple objectives on long-term investment decisions is also discussed. We find that capital market interactions have a significant impact in the way firms formulate their corporate governance, identify and control agency costs, optimize multiple objectives, make investment decisions and determine firm value. In a nutshell, there is a consensus among researchers that capital markets impact on capital investment decisions and firm value through interest rates, debt covenants that impact on managers’ self-interest behaviour, corporate governance policies and agency costs.