Corporate governance and correlation in corporate defaults

Abstract

AbstractResearch Question/IssueThis study examines the effect of weak corporate governance in terms of concentrated ownership, low board effectiveness, low financial transparency and higher shareholder rights on default correlation when firms have different credit qualities.Research Findings/InsightsUsing historical default data in the United States from 2000 to 2015, we find that the degree of default correlation increases disproportionately for firms with concentrated ownership, low board effectiveness, low financial transparency and disclosures, and higher shareholder rights. More importantly, the effect of weak corporate governance on default correlation is high during a financial crisis.Theoretical/Academic ImplicationsThis is one of the first studies testing the impact of corporate governance on the correlation in corporate defaults. It indicates new avenues of research for both corporate governance and credit risk management in relation to why joint default probabilities vary among firms.Practitioner/Policy ImplicationsOur results imply that good corporate governance is essential for credit risk management because poor corporate governance may increase individual default risk and create the domino effect of credit defaults. Practitioners and policy makers should enhance control over poor governance practices to reduce the probabilities of default. Moreover, the impact of corporate governance on correlation in corporate defaults is more pronounced in financial crises and warrants consideration from policy makers to take steps toward cushioning its effects.