Open Access Journal Article

CEO power, corporate governance, and firm leverage

by Shahbaz Sheikh a,* orcid
a
DAN Department of Management & Organizational Studies, The University of Western Ontario, London, Ontario, Canada
*
Author to whom correspondence should be addressed.
JEA  2024, 74; 3(3), 74; https://doi.org/10.58567/jea03030012
Received: 15 August 2023 / Accepted: 18 September 2023 / Published Online: 15 September 2024
View Full-Text
Download PDF

Abstract

This study empirically examines the effect of corporate governance on the relation between CEO power and firm leverage. Results from OLS and industry fixed effects regressions show that CEO power is positively associated with firm leverage. However, this association is driven by the strength of corporate governance as powerful CEOs tend to choose higher levels of debt only when corporate governance is strong. When corporate governance is weak, CEO power does not seem to have any effect on firm leverage. Overall, results indicate that strong corporate governance mitigates the severity of manager-shareholder conflicts and induces powerful CEOs to choose higher leverage.

Keywords: CEO power; corporate governance; leverage;
Copyright: © 2024 by Sheikh. This is an open-access article distributed under the terms of the Creative Commons Attribution License (CC BY) (Creative Commons Attribution 4.0 International License). The use, distribution or reproduction in other forums is permitted, provided the original author(s) or licensor are credited and that the original publication in this journal is cited, in accordance with accepted academic practice. No use, distribution or reproduction is permitted which does not comply with these terms.

Share and Cite

ACS Style
Sheikh, S. CEO power, corporate governance, and firm leverage. Journal of Economic Analysis, 2024, 3, 74. https://doi.org/10.58567/jea03030012
AMA Style
Sheikh S. CEO power, corporate governance, and firm leverage. Journal of Economic Analysis; 2024, 3(3):74. https://doi.org/10.58567/jea03030012
Chicago/Turabian Style
Sheikh, Shahbaz 2024. "CEO power, corporate governance, and firm leverage" Journal of Economic Analysis 3, no.3:74. https://doi.org/10.58567/jea03030012
APA style
Sheikh, S. (2024). CEO power, corporate governance, and firm leverage. Journal of Economic Analysis, 3(3), 74. https://doi.org/10.58567/jea03030012

Article Metrics

Article Access Statistics

References

  1. Adams, R.B., Almeida, H., & Ferreira, D. (2005). Powerful CEOs and their impact on corporate performance. Review of Financial Studies, 18, 1403–1432. https://doi.org/10.1093/rfs/hhi030
  2. Agrawal, A. & Knoeber, C.R. (1996). Firm performance and mechanisms to control agency problems between managers and shareholders. Journal of Financial Quantitative Analysis, 31(3), 377-397. https://doi.org/10.2307/2331397
  3. Amihud, Y. & Lev, B. (1981). Risk reduction as a managerial motive for conglomerate mergers. The Bell Journal of Economics, 12, 605–617. https://doi.org/10.2307/3003575
  4. Bathala, C., Moon, K., & Rao, R. (1994). Managerial ownership, debt policy and institutional holdings: An agency perspective. Financial Management, 23(3), 38-50. https://doi.org/10.2307/3665620
  5. Baum, C.F., Schaffer, M.E., & Stillman, S. (2003). Instrumental variables and GMM: Estimation and testing. The Stata Journal, 3 (1), 1-31. https://doi.org/10.1177/1536867X0300300101
  6. Bebchuk, L., Cohen A. & Ferrell, A. (2009). What matters in corporate governance?” Review of Financial Studies, 22, 783–827. https://doi.org/10.1093/rfs/hhn099
  7. Bebchuk, L., Cremers, K.J.M., & Peyer, U.C. (2011). The CEO pay slice. Journal of Financial Economics, 102, 199–221. https://doi.org/10.1016/j.jfineco.2011.05.006
  8. Berger, P. G., Ofek, E., & Swary, I. (1996). Investor valuation and the abandonment option. Journal of Financial Economics, 42, 257–287. https://doi.org/10.1016/0304-405X(96)00877-X
  9. Brickley, J.A., Coles, J.L., & Terry, R.L. (1994). Outside directors and the adoption of poison pills. Journal of Financial Economics, 35, 371–390. https://doi.org/10.1016/0304-405X(94)90038-8
  10. Chakraborty, A., Rzakhanov, Z., & Sheikh, S. (2014). Antitakeover provisions, managerial entrenchment and firm innovation. Journal of Economics and Business, 72, 30-43. https://doi.org/10.1016/j.jeconbus.2013.10.001
  11. Chintrakarn, P., Jiraporn, P., & Singh, M. (2014). Powerful CEOs and capital structure decisions: Evidence from the CEO pay slice (CPS). Applied Economics Letters, 21(8), 564–568. https://doi.org/10.1080/13504851.2013.875102
  12. Coles, J. L., Daniel, N. D., & Naveen, L. (2006). Managerial incentives and risk-taking. Journal of Financial Economics, 79(2), 431-468. https://doi.org/10.1016/j.jfineco.2004.09.004
  13. DeAngelo, H., & Masulis, R. (1980). Optimal capital structure under corporate and personal taxation. Journal of Financial Economics, 8(1), 3-29. https://doi.org/10.1016/0304-405X(80)90019-7
  14. Degryse, H., De Geoij, P., & Kappart, P. (2012). The impact of firm and industry characteristics on small firms’ capital structure. Small Business Economics, 45, 215-244. https://doi.org/10.1007/s11187-010-9281-8
  15. Fahlenbrach, R. (2009). Founder-CEOs, investment decisions, and stock market performance. Journal of Financial and Quantitative Analysis, 44, 439–466. https://www.jstor.org/stable/40505931
  16. Fama, E. & Jensen, M. (1983). Separation of ownership and control. Journal of Law and Economics, 26, 301–325. https://www.jstor.org/stable/725104
  17. Finkelstein, S. (1992). Power in top management teams: Dimensions, measurement, and validation. Academy of Management Journal, 35, 505-538. https://doi.org/10.2307/256485
  18. Fischer, E.O., Robert H. & Josef Z. (1989). Dynamic capital structure choice: Theory and tests, Journal of Finance, 43, 19–40. https://doi.org/10.2307/2328273
  19. Friend, I., & Lang, L. H. (1988). An empirical test of the impact of managerial self‐interest on corporate capital structure. Journal of Finance, 43(2), 271-281. https://doi.org/10.2307/2328459
  20. Gompers, P.A., Ishii J.L. & Metrick A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118(1), 107-156. https://www.jstor.org/stable/2505390
  21. Goyal, P., & Park, C.W. (2002). Board leadership structure and CEO turnover. Journal of Corporate Finance, 8(1), 49-66. https://doi.org/10.1016/S0929-1199(01)00028-1
  22. Grossman, S., & Hart, O. D. (1983). An analysis of the principal-agent problem. Econometrica, 51, 7-45. https://doi.org/10.2307/1912246
  23. Han, S., Nanda, V.K., & Silveri, S.D. (2016). CEO power and firm performance under pressure. Financial Management, 45(2), 369-400. https://doi.org/10.1111/fima.12127
  24. Harris, M., & Raviv, A. (1988). Corporate control contests and capital structure. Journal of Financial Economics, 20, 55–86. https://doi.org/10.1016/0304-405X(88)90040-2
  25. Hayward, M. & Hambrick, D. 1997. Explaining the premiums paid for large acquisitions: Evidence of CEO hubris. Administrative Science Quarterly, 42: 103–127. https://doi.org/10.2307/2393810
  26. Hermalin, B.E. & Weisbach, M.S. (1991). The effects of board composition and direct incentives on firm performance. Financial Management, 20, 101–112. https://doi.org/10.2307/3665716
  27. Holmstrom, B. (1999). Managerial incentives problems: A dynamic perspective. The Review of Economic Studies, 66 (1), 169-182. https://www.jstor.org/stable/2566954
  28. Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review, 76, 323–29. https://www.jstor.org/stable/1818789
  29. Jensen, M.C. & Meckling W.H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 2, 305-60. https://doi.org/10.1016/0304-405X(76)90026-X
  30. Jiraporn, P., Chintrakarn, P., & Liu, Y. (2012). Capital structure, CEO dominance, and corporate performance. Journal of Financial Services Research, 42(3), 139–158. https://doi.org/10.1007/s10693-011-0109-8
  31. Jiaporn, P., & Gleason, K. C. (2007). Capital structure, shareholder rights and corporate governance. Journal of Financial Research, 30(1), 21-33. https://doi.org/10.1111/j.1475-6803.2007.00200.x
  32. Khanna, V., Kim, E. H., & Lu, Y. (2015). CEO connectedness and corporate frauds. Journal of
  33. Finance, 70: 1203–52. https://doi.org/10.1111/jofi.12243
  34. Lee, J., Park, J. & Park S. (2015). Revisiting CEO power and firm value. Applied Economics Letters, 22(8), 597-602. https://doi.org/10.1080/13504851.2014.962216
  35. Liao, L., Mukherjee, T., & Wang, W. (2015). Corporate governance and capital structure dynamics: An empirical study. The Journal of Financial Research, 38(2), 169-191. https://doi.org/10.1111/jfir.12057
  36. MacKie-Mason, J. K. (1990). Do taxes affect corporate financing decisions? Journal of Finance, 45, 1471-1493. https://doi.org/10.2307/2328746
  37. Modigliani, F., & Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48 261–297. https://www.jstor.org/stable/1809766
  38. Morellec, E., Nikolov, B., & Schurhoff, N. (2012). Corporate governance and capital structure dynamics. Journal of Finance, 67, 803–48. https://www.jstor.org/stable/23261327
  39. Morse, A., Nanda, V., & Seru, A. (2011). Are incentive contracts rigged by powerful CEOs?” Journal of Finance 66, 1779–1821. https://www.jstor.org/stable/41305175
  40. Rajan, R. & Zingalese, L. (1995). What do we know about capital structure: Some evidence from international data. Journal of Finance, 50(5), 1421-1460. https://doi.org/10.1111/j.1540-6261.1995.tb05184.x
  41. Rosenstein, S. & Wyatt, J.G. (1997). Inside directors, board effectiveness, and shareholder wealth. Journal of Financial Economics, 44, 229–250. https://doi.org/10.1016/S0304-405X(97)00004-4
  42. Ryan, H.E., & Wiggins, R.A. (2004). Who is in whose pocket? Director compensation, board independence, and barriers to effective monitoring. Journal of Financial Economics, 73, 497–524. https://doi.org/10.1016/j.jfineco.2003.11.002
  43. Sheikh, S. (2018). CEO power, market competition and firm value. Research in International Business and Finance, 46, 373-386. https://doi.org/10.1016/j.ribaf.2018.04.009
  44. Sheikh, S. (2019). CEO power and corporate risk: The impact of market competition and corporate governance. Corporate Governance: An International Review, 27(5), 358-377. https://doi.org/10.1111/corg.12285
  45. Sheikh, S. (2022). CEO power and the likelihood of paying dividends: Effect of profitability and cash flow volatility. Journal of Corporate Finance. (forthcoming) https://doi.org/10.1016/j.jcorpfin.2022.102186
  46. Smith, C. W., & Stulz, R. M. (1985). The determinants of firms’ hedging policies. Journal of Financial and Quantitative Analysis, 20, 391-405. https://doi.org/10.2307/2330757
  47. Stock, J. H., Wright, J. H., & Yogo, M. (2002). A survey of weak instruments and weak identification in generalized method of moments. Journal of Business and Economic Statistics, 20, 518–529. https://doi.org/10.1198/073500102288618658
  48. Stulz R (1988). Managerial control of voting rights: financing policies and the market for corporate control. Journal of Financial Economics, 20, 25–54. https://doi.org/10.1016/0304-405X(88)90039-6
  49. Sun, J., Ding, L., Guo, J. M., & Li, Y. (2016). Ownership, capital structure and financing decision: Evidence from the UK. The British Accounting Review, 48, 448-463. https://doi.org/10.1016/j.bar.2015.04.001
  50. Tang, J., Crossan, M., & Rowe, W.G. (2011). Dominant CEO, deviant strategy, and extreme performance: The moderating role of a powerful board. Journal of Management Studies, 48, 1479–1503. https://doi.org/10.1111/j.1467-6486.2010.00985.x
  51. Villalonga, B., & Amit, R. (2006). How do family ownership, control and management affect firm value? Journal of Financial Economics, 80(2), 385-417. https://doi.org/10.1016/j.jfineco.2004.12.005
  52. Weisbach, M.S. (1988). Outside directors and CEO turnover. Journal of Financial Economics, 20, 431–460. https://doi.org/10.1016/0304-405X(88)90053-0
  53. Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of Financial Economics 40, 185–211. https://doi.org/10.1016/0304-405X(95)00844-5
  54. Zwiebel, J. (1996). Dynamic capital structure under managerial entrenchment. American Economic Review 86, 1197–1215. https://www.jstor.org/stable/2118286