Corporate Governance and Financing Policy: New Evidence

Abstract:     
Prior research has often taken the view that entrenched managers tend to avoid debt. Contrary to this view, we find that firms with entrenched managers, as measured by the Gompers et al. (2003) governance index, actually use more debt finance and have higher leverage ratios. This increased use of debt by entrenched managers is higher with higher ownership by large shareholders. To address the potential endogeneity of the governance index, we use both instrumental variables analysis and the exogenous shock to corporate governance generated by the adoption of state anti-takeover laws. We examine several explanations for this behavior. Our evidence is consistent with entrenched managers receiving better access to debt markets (better credit ratings) and better financing terms (perhaps in response to the conservative investment policy that they pursue). We also document a positive stock price response to the announcement of debt issues by entrenchment managers. Our result on the positive relationship between entrenchment and debt continues to hold even after controlling for the possibility that managers use debt as an entrenchment device.

Keywords: Financing policy, capital structure, corporate governance, shareholder rights, managerial risk-taking

JEL Classifications: G31, G32, G34

Working Paper Series