Corporate Governance and the Dynamics of Capital Structure: New Evidence

Abstract

The empirical literature provides the effect agency conflicts on capital structure choices. Yet previous researchers fail to recognize the impact of corporate governance quality on the adjustment speed of capital structure. Especially, this paper considers two different views (the defense effect of debt vs. the disciplining effect of debt) at the same time. For underlevered firms, bad governance firms get more disadvantages from the discipline of debt than advantages from avoiding takeover by outsiders when they increase debt. However, for overlevered firms, bad governance firms would voluntarily choose more debts to prevent potential raiders when they face the serious threat of takeover. Therefore, firms with bad governance have slower adjustment speed toward target debt level, for both under- and over- levered ones, albeit with different motivations.

Keywords: dynamic capital structure, speed of adjustment, corporate governance

JEL Classification: G32, G34