Profits, financial leverage and corporate governance
ORCID Identifiers
Document Type
Article
Source of Publication
International Journal of Managerial Finance
Publication Date
8-26-2019
Abstract
© 2019, Emerald Publishing Limited. Purpose: The purpose of this paper is to identify the impact of governance structures in defining the relationship between profits and leverage. Design/methodology/approach: The paper uses the standard design used by Fama and French (2002) and employs it under different governance structures. It is the first to identify the endogenous nature of the relationship between profits and leverage, compounded by the endogeneity of governance. The paper uses the instrumental variable (IV) technique to control for endogeneity and recommends a novel approach to control for multiple endogenous regressors. Findings: The results demonstrate that firms operating under good governance verify the predictions of the trade-off theory of capital structure and that the evidence of negative relation in the literature is a subset of management inefficiency. The results are consistent after controlling for endogeneity and are robust to alternative iteration of governance. The activity in debt issuance and retirement supports the conclusion that firms with good governance structures actively seek an optimal capital structure corresponding to profits. Originality/value: This study adds value to existing literature. It is the first to identify the importance of governance in defining the relationship between profits and leverage. It recognizes unaccounted endogeneity concerns and employs an inspired IV approach to control for feedback from multiple endogenous regressors. Evidence for capital structure adjustment by firms with good governance is also substantiated. Lastly, the first unqualified evidence for the trade-off model is provided.
DOI Link
ISSN
Publisher
Emerald Group Publishing Ltd.
Volume
16
Issue
2
First Page
203
Last Page
223
Disciplines
Business
Keywords
Corporate governance, Leverage, Profits, Trade-off theory
Scopus ID
Recommended Citation
Butt, Umar, "Profits, financial leverage and corporate governance" (2019). All Works. 2821.
https://zuscholars.zu.ac.ae/works/2821
Indexed in Scopus
yes
Open Access
no