Corporate Governance, Internal Control and Leverage: Are We There Yet?

Abstract

Corporate governance serves as a robust internal control mechanism. Literature has established that strong corporate governance improves oversight, accountability, and transparency. In the governance and leverage literature, agency theory and pecking order theory suggest that strong governance mechanisms reduce leverage, as stronger governance provides good internal control to check managerial opportunistic behaviors, preventing overinvestment and other entrenchment practices through excessive borrowing. However, leverage may itself act as an external disciplinary mechanism, thereby substituting the need for strong internal governance. Almost two decades of studies exist investigating the relationship between corporate governance and leverage without a clear direction. Furthermore, we investigate the relationship between corporate governance and the speed of leverage adjustment, revealing a consensus among many studies that firms subject to strong governance adjust their leverage more expeditiously than those under weak governance. Our current study synthesizes prior research and points toward the direction of improvement.