Corporate Governance as a Mechanism to Mitigate Financing Constraints on Investment

Abstract

This paper addresses whether adopting good governance standards alleviates constraints on financing investment via improved internal efficiency or access to external capital. The Russian context serves as an appropriate setting for studying the longitudinal effect of governance. I use transparency and disclosure (TD) scores computed by Standard and Poor’s (S&P) as the primary proxy for corporate governance, supported by shareholder ownership structure. I find that corporate governance has a positive and significant impact on fixed investment. However, my findings indicate that for oligarch-owned firms, this relationship might be curvilinear. State owned enterprises (SOEs) are more sensitive than oligarch-owned enterprises to improved governance, but less sensitive to the changes in internal funds (cash-flows). I elaborate on possible interpretations of these findings. Firstly, SOEs are poorly governed judging by their S&P TD scores, therefore, any improvements to their governance might have a more significant effect on their fixed investment. Secondly, the absence of investment-cash-flow sensitivity for SOEs might be due to soft budget constraints.I find that governance of financially constrained firms positively and significantly affects investment. Governance, therefore, is a valid mechanism for reducing financing constraints on investment. The empirical analysis is conducted on an eight-year panel dataset containing observations on the largest Russian companies, publicly listed in Russia or abroad. Robustness checks and controls for endogeneity include dynamic panel generalized method of moments (GMM), difference-in-difference estimator (DID), based on an exogenous event (introduction of Russian governance code) and vector autoregression (VAR) techniques.