Capital structure and corporate governance quality: Evidence from the Institutional Shareholder Services (ISS)

• Published in: International review of economics & finance 2012-04, Vol.22 (1), p.208-221
• Main Authors: Jiraporn, Pornsit, Kim, Jang-Chul, Kim, Young Sang, Kitsabunnarat, Pattanaporn
• Format: Article
• Language: English
• Subjects: Agency costs; Agency theory; Capital structure; Corporate governance; Leverage; Stockholders; Studies
• ISSN: 1059-0560; 1873-8036
• DOI: 10.1016/j.iref.2011.10.014

Grounded in agency theory, this study explores how capital structure is influenced by aggregate corporate governance quality. We measure governance quality using broad-based comprehensive governance metrics provided by the Institutional Shareholder Services (ISS). The empirical evidence reveals a robust inverse association between leverage and governance quality. Firms with poor governance are significantly more leveraged. It appears that leverage substitutes for corporate governance in alleviating agency conflicts. Further, we utilize empirical methods that control for endogeneity and show that poor governance quality likely brings about, and does not merely reflect, higher leverage. Our results are important as they show that the overall quality of corporate governance has a material impact on critical corporate decisions such as capital structure choices. ► We examine how capital structure is influenced by corporate governance quality. ► We show inverse relation between leverage and governance quality. ► Leverage substitutes for corporate governance in alleviating agency conflicts. ► Quality of corporate governance has material impact on capital structure decisions.