Beyond the balance sheet: Assessing corporate governance through the Lens of debtholders

• Published in: International review of financial analysis 2024-11, Vol.96, p.103625, Article 103625
• Main Authors: Al-Gamrh, Bakr, Farooq, Umar, Ahsan, Tanveer
• Format: Article
• Language: English
• Subjects: Corporate governance; Cost of debt; Economic uncertainty; Economics and Finance; Europe; Humanities and Social Sciences
• ISSN: 1057-5219
• DOI: 10.1016/j.irfa.2024.103625

This study investigates the relationships between economic uncertainty (EU), corporate governance (CG), and the cost of debt (COD). Using an index-based measure of CG, this study investigates how CG influences debtholders' perspectives during periods of EU. The study utilizes a dataset of nonfinancial firms listed in European countries from 2013 to 2021. We find that EU and COD are positively associated, indicating that EU increases the COD of European firms. Second, while CG has an insignificant direct impact on COD, it has a significant negative moderating impact on the relationship between EU and COD, suggesting that although a strong CG system may not have a significant direct impact on COD, it has the potential to reduce the uncertainty-induced COD of European firms. The results remain consistent with alternative proxies of COD and CG, as well as before and after the COVID-19 period. The results for CG subindices suggest that shareholder rights and compensation serve as reliable indicators for debtholders during periods of EU, while audit quality and board structure do not play any significant role in reducing uncertainty-induced COD. Our findings emphasize the key role that effective CG plays in mitigating EU's adverse effects on COD. Our results are robust to endogeneity issues such as reverse causality and selection bias, as well as to external factors like time and industry effects. •The study investigates the association between economic uncertainty, corporate governance, and corporate cost of debt.•Economic uncertainty has an adverse impact on corporate cost of debt.•Effective corporate governance mitigates the adverse impact of economic uncertainty on cost of debt.•Corporate governance strength influences debtholders' perceptions during periods of economic uncertainty.