Capital Structure and Corporate Governance Quality: Evidence from the Institutional Shareholder Services (ISS)
40 Pages Posted: 4 Oct 2011
Date Written: October 4, 2011
Grounded in agency theory, this study explores how capital structure is influenced by aggregate corporate governance quality. We employ broad-based governance measures that encompass multiple factors, including boards, audit quality, charter/bylaws, director quality, executive compensation, ownership, and state of incorporation. We document a robust negative association between leverage and governance quality. The evidence reveals that firms with poor governance are significantly more leveraged. It appears that leverage substitutes for corporate governance in alleviating agency conflicts. We also present supportive evidence that leverage helps firms raise capital by sending a signal to the capital markets about the firm’s governance. Finally, we utilize empirical methods that control for potential endogeneity and show that poor governance quality likely brings about, and does not merely reflect, higher leverage. Our results are important as they show that the overall quality of corporate governance has a material impact on critical corporate decisions such as capital structure choices.
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