The Nexus Between Relationship of Environmental Uncertainty and
Capital Structure: Corporate Governance as Moderator
TRIYONOWATI1, RIZKI AMALIA ELFITA2, NUR LAILY3, SUWITHO4
1,3,4Department Of Management, Sekolah Tinggi Ilmu Ekonomi Indonesia (STIESIA) Surabaya,
Surabaya, INDONESIA
2Department Of Accounting, Faculty of Economy Business and Digital Technology, Universitas
Nahdlatul Ulama, Surabaya, INDONESIA
Abstract: - Changes in the external environment create uncertainty for the company. This study aims to find
empirical evidence of the effect of environmental uncertainty on the capital structure of companies moderated
by corporate governance. The research was conducted on manufacturing companies in Indonesia during 2014-
2018. Data were analyzed using moderated regression analysis. The findings show that the effect of
environmental uncertainty on the company's capital structure and the moderating ability of corporate
governance strengthens the effect of environmental uncertainty on the company's capital structure. The
contribution of this finding is useful for company owners, where when environmental uncertainty is higher and
corporate governance is getting better, it actually makes managers try to allocate greater debt into their capital
structure. It is better if the owner does not easily believe in the results of performing of his managers and
remains under periodic control. Another contribution of this finding is also reminiscent of the concept of
pecking order theory, which has been underestimated.
Key-Words: - Capital structure, environmental uncertainty, corporate governance, environmental management.
Received: September 21, 2021. Revised: July 12, 2022. Accepted: August 2, 2022. Published: September 5, 2022.
1 Introduction
Changes in the economic and market
environment that never stop is a contingency factor
facing companies [1]. Two constructions of the
business environment experienced directly by
companies are environmental dynamics and
environmental uncertainty [2]. A dynamic
environment is characterized by a constant rate of
change in consumer demand, but opportunities to
create new markets remain open. In this
environment, companies need to change products to
meet changing customer preferences and secure
their competitive advantage [3]. This condition must
also be read well by the company's management
because rapidly changing customer preferences are
difficult to predict [4].
In addition, the environmental uncertainty that is
being faced can also affect the company's
performance [5]. This occurs because of rapid
changes in uncertain conditions. Environmental
uncertainty requires management's ability to
accurately understand external environmental
conditions. This is because of the difficulty in
anticipating and assimilating environmental
conditions simultaneously [6]. Environmental
uncertainty is often driven by intense competition
and the unpredictable pace of technological
progress. In such an environment, product cycles are
often short, forcing firms to invest more in
technology to face competition [5], [7], [8]. In a
competitive environment, which is characterized by
the pace of technological change, investment in
technology plays an important role in achieving and
maintaining its competitive advantage [9]–[11].
Investing in technology also helps companies
increase capacity and develop new products that can
adapt to market uncertainties (Ramirez et al., 2018).
In addition, companies are expected to understand
changing market trends and produce new products
in a rapidly changing business environment.
Environmental uncertainty that grows from
business competition also encourages company
management to be more innovative in developing
new ideas that differ from competitors [12]–[14].
This condition encourages company management to
invest in creating new products and processes from
ideas generated by company management. In
addition, the rapidly changing technological changes
also need to be responded well by company
managers so that the technology owned by the
company can be useful for the company in order to
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win the competition in an uncertain business
environment. Uncertainty in the business
environment results in the need for companies to
invest in technology and research and development,
which causes changes in the company's capital
structure. An uncertain business environment
increases the company's debt on the company's
capital structure because of the enormous
investment costs required in a condition of
environmental uncertainty [15], [16].
The large investments made by the company's
management during this time of high environmental
uncertainty also paved the way for the company's
management to take opportunistic actions.
Therefore, a strong corporate governance role can
limit the possibility of opportunistic actions taken
by management. Corporate governance encourages
company management to be more careful in
managing the company's capital structure under
uncertain environmental conditions [15]. Corporate
governance provides greater support to corporate
managers in the face of environmental uncertainty
[5], [17]. This support helps company managers to
make technology investments. This condition results
in an increase in debt in the corporate structure
when corporate governance gives managers
flexibility to change business strategies in an
uncertain environment. This needs to be monitored
to prevent the increase in the level of debt in the
company [12], [16], [18]. Therefore, it is necessary
to conduct an empirical study to determine the
relationship between environmental changes and
changes in the capital structure of a company
moderated by corporate governance. The
contribution given can certainly help the owners or
stakeholders before they decide to approve or reject
the proposals of their managers when an internal
meeting is held on environmental changes and for
the sake of the company's sustainability.
The theoretical basis and some other literature
that is still being debated will be presented to raise
the problem hypothesis. This hypothesis will be
tested using the formulation of the method described
in the next chapter, then the findings got will be
analyzed and discussed to provide useful
conclusions for interested parties.
2 Literature Review
2.1 Business Environment Challenges
The business environment has undergone
significant changes [17]. These changes are
expected to be increasingly complex and difficult to
predict. The business environment (will) be
increasingly turbulent. Globalization is one of the
major causes of the increasingly turbulent business
environment today. Globalization reflects the
opportunity for business organizations to develop
through the exploitation of international markets at a
more efficient cost [25], [26]. This condition also
encourages the creation of tighter competition
between business organizations. The increasingly
fierce competition has forced business organizations
to find new ways to survive. Besides being customer
oriented, business organizations must also be
efficient. As a result, many business organizations
are reducing employees. The size of the
organization is smaller because they are downsizing
to be more flexible.
Smaller organizations don't have to reduce
activities. As a result, business organizations need to
introduce new ways of getting things done. Jobs are
no longer mechanistically designed. Independent
groups, self-managed teams or semi-autonomous
work teams, are a new way of getting work done.
The group is given great authority to get the job
done. In addition to increasingly fierce competition,
external environmental pressures are also getting
higher.
Business environment can be divided into two
categories, namely: the external and internal
environment [17], [27]. The external environment is
divided into two categories, namely: the remote
environment and the industrial environment, while
the internal environment is the aspects that exist
within the company. The remote environment
includes political, economic, social and
technological factors; industrial environment
includes aspects contained in the concept of
competitive strategy (competitive strategy) which
includes aspects of barriers to entry, aspects of
supplier bargaining power, aspects of buyers'
bargaining power, aspects of the availability of
substitute goods and aspects of competition in the
industry. The company's internal environment
includes aspects of finance, human resources,
marketing, operations and management aspects.
The business environment can also affect all
aspects of the business, both at the organizational
and individual levels. Competence will distinguish
people who perform well with mediocrity.
Competence can be in the form of motives, talents
or traits, self-concept, attitudes or values or
attitudes, self-knowledge, or cognitive skills in
behavior. In general, the competence of an
entrepreneur is the same as that of a manager, plus
the ability to read opportunities and self-
management [28], [29]. This is because an
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entrepreneur, apart from being a business owner
(manager) is also a business executor, so it is very
necessary to have the ability to see and take
advantage of the opportunities that exist as well as
possible, while to be able to take advantage of
existing opportunities, an entrepreneur must have
good self-management, and able to manage their
own abilities, so that they can improve their
business abilities.
2.2 Environmental Uncertainty and
Corporate Capital Structure
Fast and gradual changes in technology, fast-
changing consumer preferences, and fluctuations in
product supply or demand of materials are
contingent problems faced by companies. These
conditions create environmental uncertainty that can
disrupt the sustainability of the company’s life [27],
[30]. This shows that environmental uncertainty is a
contingent problem that can make it more difficult
for company management to predict the
sustainability of the company in the future because
of changes in the external environment. Changes in
the external environment encourage management to
become more active in creating internal and external
contingency factors in response to environmental
changes [6], [31].
Environmental uncertainty is a condition
that arises because of business changes, so they
must be effective steps taken by company
management to overcome environmental uncertainty
[31]. When a company faces with an uncertain
business environment, a leader must be able to
understand how to expect by minimizing the impact
of an uncertain business environment. The higher
the environmental uncertainty, the less revenue the
company will have, and the possibility of potential
cash flow shortages [32]. Therefore, the company
will increase external funding to meet the cash flow
needs and technology investment and research and
development needs in a dynamic economic
environment. Environmental uncertainty encourages
management to become more aggressive in
allocating debt to the corporate capital structure to
meet the company’s needs. Investment in research
and development and in technology requires large
funding, so they are not met by internal funding.
H1. Environmental uncertainty has a positive
impact on the corporate capital structure.
2.3 Environmental Uncertainty, Corporate
Governance and Corporate Capital
Structure
Good corporate governance can predict or manage
all the risks that the company might face in the
future [33]. The ability to predict or manage all the
risks that might be faced by the company makes
corporate governance more active in informing
management about risks in the future, so that
management becomes more confident that the
decisions they have made are the right one [33].
Uncertainty in the business environment is a
condition that cannot be avoided, therefore company
management must be able to manage the risks that
might be faced by the company so that the company
has the minimum impact because of the uncertainty
of the business environment.
Companies are required to manage
environmental uncertainty through innovative
efforts to maintain the company’s position in a
competitive environment [34]. Environmental
factors provide opportunities, constraints, and
threads, therefore influence the attractiveness and
ability of the company to innovate [35]. To maintain
the company’s position in a competitive
environment, the company management strives to
be more active in conditions of high environmental
uncertainty by investing in research and
development and in technology to keep up with
changes caused by environmental uncertainty.
Corporate governance is active in performing its
functions properly in times of high environmental
uncertainty. Corporate governance provides greater
support to company managers to overcome
environmental uncertainty [17], [33], [36]. This
support makes it easier for company managers to
make greater investments in technology and
research and development to have better
management in high environmental uncertainty.
This condition results in increased debt in the
corporate capital structure when corporate
governance allows managers to change the
company’s business strategy in environmental
uncertainty.
H2. Corporate governance strengthens the influence
of business environment uncertainty on the
corporate capital structure.
Fig. 1: Conceptual Framework
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3 Research Method
This study discusses 3 major problems, namely the
uncertainty of the business environment, corporate
governance, and the corporate capital structure.
Model 1:
DER = β₀ + β₁EU + β4TANGIBLE + β5SIZE + ε
DER is the corporate capital structure,
EU shows the environmental uncertainty,
TANGIBLE represents corporate tangibility,
SIZE shows the size of the company, and ε is an
error.
The corporate governance index represented by
CG.
EU*CG is a description of the interaction
between environmental uncertainty and corporate
governance.
The dependent variable (DER) is measured as
total debt over total equity
Model 2:
DER = β₀ + β₁EU + β2CG + β4TANGIBLE +
β5SIZE + ε
Model 3:
DER = β₀ + β₁EU + β2CG + β3 EU*CG +
β4TANGIBLE + β5SIZE + ε
To measure the quality of corporate
governance, we use a principal component analysis
method to deal with the multidimensional aspects of
governance mechanisms [17], [37]. It is used to
combine individual governance characteristics to
construct a single governance index. The corporate
governance (CG) index is calculated based on a
linear combination of the following individual
governance measures:
Where governance it represents an
individual measure of governance m from a
company i in the year of t and loading is the
assignment for the individual governance measure
m of a company i.
This study combines several company-
specific control variables that were found to have a
significant influence on the corporate capital
structure decisions in previous studies. The
company-specific control variables are tangibility
asset (TANGIBLE), which are measured as the ratio
of fixed assets to total assets [38], [39], and
company size (SIZE), which is measured based on
the natural logarithm of total assets [40]–[42].
The analysis used in this study is moderated
regression analysis (MRA). MRA is used to
examine the moderating effect of corporate
governance on the effect of environmental
uncertainty on the corporate capital structure.
4 Results
4.1 Descriptive Statistics
Descriptive statistics are presented in Table 1. Based
on the results shown in Table 1, the average value of
the corporate capital structure (DER) is 0,30413
with a standard deviation of 0,34254 yang which
shows that manufacturing companies in Indonesia
use the equity in the corporate capital structure,
which is showed by an average value of less than 1.
The average value of the uncertainty of the business
environment is equal to 0.19325 with a standard
deviation of 0.16858 which shows that the level of
uncertainty in the business environment (EU) is not
too high, it can be seen from the average value of
less than 1. The average value of corporate
governance (CG) is 0,36268 with a standard
deviation of 0,13660, which shows the disclosure of
corporate governance in manufacturing companies
in Indonesia is not good because the mean value is
less than 1. The average value of tangibility assets is
0,38732 with a standard deviation of 0,19406, which
shows that the tangibility asset of manufacturing
companies in Indonesia is quite large, meaning that
it is easier for companies to pledge their assets to get
debt. The average value of company size is
28,48741 with a standard deviation of 1,62767
which shows that the size of the manufacturing
companies in Indonesia as the research sample is
relatively the same.
Tabel 1. Descriptive Statistics
N
Min.
Max.
Mean
Std.
Deviatio
n
DER
528
0.0006
3.180
0.304
0.342
EU
528
0.0154
1.633
0.193
0.168
CG
528
0.0774
0.612
0.362
0.136
TANGIBLE
528
0.0005
0.965
0.387
0.194
SIZE
528
24.4141
33.473
28.487
1.627
Valid N
(listwise)
528
Source: Research Data, 2020.
Table 2 describes the correlation between the
main variables. The correlation between variables is
relatively low, as shown by the Pearson correlation
value, which is less than 0,3. A moderate level of
correlation occurs between company size and
corporate governance, where the correlation value is
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equal to -0,545. Therefore, we conclude that
multicollinearity is not a problem for regression.
Tabel 2. Correlation Between Variabel
DER
EU
CG
TANGIBLE
SIZE
DER
1
EU
0,080
1
CG
-0,131
-0,063
1
TANGIBLE
0,311
-0,077
-0,054
1
SIZE
0,257
-0,158
-0,545
0,219
1
Source: Research Data, 2020.
4.2 Main Regression Results
Table 3 presents the major results of the empirical
analysis. The analysis began by estimating the effect
of environmental uncertainty on the corporate
capital structure, then adds corporate governance as
a moderation. We started by estimating the effect of
environmental uncertainty on a corporate capital
structure in the presence of other control variables.
In Model 1, the relationship between environmental
uncertainty and corporate capital structure is
significantly positive at the 1 percent level. This
result supports H1. This implies that manufacturing
companies use more of their capital structure when
they face increased volatility in an uncertain
environment [15], [16]. The next was estimating the
effect of environmental uncertainty and corporate
governance on the corporate capital structure in the
presence of other control variables. In Model 2, the
relationship between environmental uncertainty and
corporate capital structure is significantly positive at
the 1 percent level, while corporate governance does
not affect.
Finally, this study estimated the relationship
between environmental uncertainty and capital
structure as moderated by corporate governance. In
Model 3, the relationship between environmental
uncertainty and corporate capital structure as
moderated by corporate governance is significantly
positive at the 5 percent level. Evidence suggested
that better corporate governance will allow
managers to use the corporate capital structure
during times of high volatility, which supports
contingency theory. The support from the corporate
governance component made it easier for company
managers to invest more in technology and research
and development to manage high environmental
uncertainty. This condition resulted in increased
debt in the corporate capital structure when
corporate governance allows managers to change
the company’s business strategies in environmental
uncertainty conditions.
The relationship between tangibility and
corporate capital structure is significantly positive at
the 1 percent level, which supports the trade-off
theory. According to this theory, firms with higher
intangibles have more fixed assets that can be
offered as collateral loans. It also reduces the risk of
the bank when making loans to such companies. As
a result, companies with high tangible assets often
find it easier to get debt financing [36]. The
coefficient of the company size is significantly
positive at the 1 percent level. This is consistent
with the trade-off theory, which states that large
companies have more reputation and diversification,
and have a smaller probability of bankruptcy. These
factors allow large companies to use more of the
corporate capital structure.
Overall, the results show that manufacturing
companies in Indonesia consider the volatility in
environmental uncertainty when planning their
financial policies. The findings of this study can
strengthen the important role of corporate
governance as an effective mechanism to limit the
use of corporate capital structure during times of
high volatility.
Tabel 3. Hypothesis Test Results
Variable
Model 1
Model 2
Model 3
Coeff
Sig
Coeff
Sig
Coeff
Sig
Constant
-1,247***
0,000
-1,212***
0,000
-0,994***
0,003
EU
0,277***
0,001
0,276***
0,001
-0,231
0,374
CG
-0,021
0,861
-0,287
0,104
EU * CG
1,234**
0,040
TANGIBLE
0,482***
0,000
0,483***
0,000
0,487***
0,000
SIZE
0,046***
0,000
0,045***
0,000
0,041***
0,000
*Significant at p-value < 0,1; ** Significant at p-value < 0,05; ***Significant at p-value <
0,01
5 Conclusions
This study discusses how corporate governance
moderates the influence between environmental
uncertainty and corporate capital structure using
unbalanced panel data from 528 manufacturing
companies listed on the Indonesia Stock Exchange
during the 2014-2018 period. The researcher applied
the moderated regression analysis model to test the
relationship of each variable in the research model.
Environmental uncertainty is proxies by the
volatility of sales volume. The results showed that
environmental uncertainty has a significant positive
effect on the decision of the capital structure of
manufacturing companies. This study finds that the
overall effect of environmental uncertainty on
company capital structure among companies with
better governance is positive. Evidence suggested
that better corporate governance supports the
corporate manager’s effort to become increasingly
aggressive in using the corporate capital structure
during times of high sales volatility.
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This study has limitations in discussing the role
of each component of corporate governance in
moderating the relationship of environmental
uncertainty to the corporate capital structure. This
study only examined the overall corporate
governance of the existing components to see its
effect on the relationship between environmental
uncertainty and corporate capital structure.
Concerning the research implications, the findings
of this study contribute to the literature on corporate
capital structure and corporate governance by
providing further evidence on how environmental
uncertainty affects the decision of corporate capital
structure, as well as how corporate governance
moderates these relationships. These results may be
useful for policymakers to plan policies to reduce
the adverse effects caused by environmental
uncertainty. This is important because
environmental uncertainty may have a potentially
destabilizing effect on a corporate company’s ability
to form excellent investment, production, and
financial decisions. Besides, the results show that
the quality of good governance can act as a
supervisor and encourage company management to
ensure that companies use more leverage when they
face volatility in the business environment. These
findings can help reinforce the importance of
coordination between company policymakers and
company managers. Last, these findings can serve
as an important guide for company managers and
investors to enable them to plan financing and
investment decisions.
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