Corporate governance and the probability of default

Abstract

We employ Merton's probability of default as a continuous ex-ante measure of the likelihood of firm failure and dynamic panel generalised method of moments to better characterise the relationship between corporate governance and the chance of default. In doing so, we overcome limitations of discrete proxies widely used in previous studies and more completely account for endogeneity issues permeating this area of research. While initial testing designed to facilitate comparison with previous studies suggests a significant relationship between the probability of default and executive pay, board structure and ownership structure, once endogeneity concerns are accounted for, no such relationship remains.

Determinants and consequences of financial distress: review of the empirical literature

“…(), Schultz et al . (), Simpson and Gleason (), and Wang and Deng () do not find any significant relation between board size and the likelihood of company failure, whereas Fich and Slezak () find a positive relation between board size and the possibility of bankruptcy. These mixed findings may be attributed to researchers' inability to incorporate into their models the process through which corporate boards operate.…”

Does corporate governance quality affect default risk? The role of growth opportunities and stock liquidity

“…Furthermore, to the best of our knowledge, only two studies investigate the role of individual governance mechanisms in the default risk for Australian firms and find mixed results. One study finds that certain governance mechanisms reduce ex-post financial distress (Miglani et al, 2015) whereas the other study finds that corporate governance does not matter for ex-ante default risk (Schultz et al, 2015). However, both these studies find the irrelevance of board structure with default risk (see section 2 for details).…”

“…Although these studies find a significant role for various governance mechanisms in prediction of bankruptcy and financial distress; but these studies are conducted in an 'expost' setting, which is subject to criticism in terms of non-random sampling design because it imposes substantial limitations on the sample available for investigation (see Balcaen and Ooghe, 2006). 2 Relatively little effort has been made to empirically investigate the role of corporate governance in the ex-ante default risk (e.g., Chiang et al, 2015;Schultz et al, 2015). Overall, these studies consider individual governance mechanisms (instead of a composite governance index), thus miss out effects from overall governance quality (Henry, 2008).…”

Evidence of governance arbitrage by private equity sponsors

“…For example Schultz et al . () modelled default probability and note the limitations of discrete proxies in accounting for endogeneity issues. A further advantage of SFA is the ability to identify variables that account for a shortfall.…”