Does Corporate Governance Matter More for Firms with High Financial Slack?

Management Science, Vol. 63, No. 6, June 2017, pp. 1872–1891

Posted: 8 Aug 2018

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Lily Li

Temple University - Department of Finance

Jiaren Pang

Tsinghua University - School of Economics & Management

Date Written: July 21, 2013

Abstract

The effect of corporate governance may depend on a firm’s financial slack. On one hand, financial slack may be spent by managers for their private benefits; a high level is likely associated with severe agency conflicts. Thus corporate governance matters more for high financial slack firms (i.e., the wasteful spending hypothesis). On the other hand, financial slack provides insurance against future uncertainties; a low level may signal deviations from the best interests of shareholders. Then corporate governance is more effective for low financial slack firms (i.e., the precautionary needs hypothesis). We differentiate the two hypotheses using the passage of antitakeover laws to identify exogenous variation in governance. Consistent with the wasteful spending hypothesis, the laws’ passage has a larger negative impact on the operating and stock market performance of high financial slack firms. Further analysis shows that these firms do not invest more but become less efficient at cost management after the laws’ passage.

Keywords: corporate governance, financial slack, business combination laws

JEL Classification: G34, G38

Suggested Citation

John, Kose and Li, Lily Yuanzhi and Pang, Jiaren, Does Corporate Governance Matter More for Firms with High Financial Slack? (July 21, 2013). Management Science, Vol. 63, No. 6, June 2017, pp. 1872–1891. Available at SSRN: https://ssrn.com/abstract=3217619

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Lily Yuanzhi Li

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States

Jiaren Pang (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

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