Abstract
The purpose of this article is to extend the bundles of corporate governance theory and propose the role of corporate debt in determining the governance structure of a company. This research intended to answer some questions have been put forward by scholars to explain the inter-relationship between debt, corporate governance, and agency costs: (i) what exactly is the disciplinary role of debts? (ii) how is governance structure influenced by the debt level? and (iii) are extremely high debt ratios required? Previous works have looked at interrelations between debt, corporate governance, and agency costs in isolation result in inclusive findings. However, we argue that debt level is a key determinant of the effective governance structure that maintains agency costs at the optimal level. Based on the governance bundle theory, we contribute to the literature by introducing a new model (over-governance model) that suggests financial leverage as a critical contingency linking governance bundle and agency costs. Also, it provides a clear picture on the different type of agency costs. Our paper provides a theoretical framework to guide further studies and provide important implications for the board, corporate management, and regulators.
Highlights
The initial debate of the capital structure has started by Modigliani and Miller (1958) who argued that the structure of capital within firms are not related to their valuations
The questions introduced by Lambrecht and Myers (2008) as: what exactly is the disciplinary role of debts? How is governance structure influenced by the debt level? Are extremely high debt ratios required? remain unanswered
Based on our model we argue that debt has a double edge agency costs and corporate governance structure in which the rational used debt, apart from the tax deduction advantages, and free cash flow reduction, would rationalize the monitoring activities practices from the owners upon the top management as it increases equity ownership share of managers and it concentrates on voting power as debt is non-voting
Summary
The initial debate of the capital structure has started by Modigliani and Miller (1958) who argued that the structure of capital within firms are not related to their valuations. As discussed in an earlier section that governance mechanisms are best viewed in combination, we build a Technium Social Sciences Journal Vol 9, 384-396, July 2020 ISSN: 2668-7798 www.techniumscience.com model based on governance bundle theory that simultaneously links governance structure, debt, and agency cost. A movement along the governance bundle curve between level of debt and agency costs represents substitutability between external and internal disciplinary mechanisms, a company would shift in between governance bundle and debt level to an establish efficient governance structure with optimal agency costs, for example, a small number of members on the boardroom followed by an increase in the debt level because of the monitoring advantages of debt. The cost trade-offs Maintains the combination near to the curve apex (Ward et al 2009)
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