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Is leverage a substitute or outcome for governance? Evidence from financial crises

Hasan Tekin (Karabuk University, Karabük, Turkey)
Ali Yavuz Polat (Abdullah Gul University, Kayseri, Turkey)

International Journal of Emerging Markets

ISSN: 1746-8809

Article publication date: 1 June 2021

Issue publication date: 21 March 2023




The authors investigate the impact of governance on the leverage of East Asian firms in the financial crisis context, in order to understand the puzzle whether debt acts as a substitute for governance or an outcome of the governance mechanism.


The authors use 86,030 firm-years and the country-level governance data from eight East Asian countries over the period 1996–2017. The authors employ the fixed effects (FE) model, in the main analysis and the weighted least squares model, as a robustness check in order to compare the two competing hypotheses of agency theory, substitute and outcome models.


The authors’ results show that debt acts as a substitute for governance before the GFC, but during and after the GFC the picture changes. Namely, debt acts as an outcome of the governance mechanism during the GFC and its aftermath. Since during financial downturns both agency costs increase, and information asymmetry widens, firms in poor-governed countries may be reluctant to increase their leverage in order not to face financial distress and additional restrictions. Thus, the results imply that the use of debt as a tool to mitigate agency conflicts and a substitute for governance strongly depends on the environment that the firms operate and the general macroeconomic conditions, such as facing a financial crisis or not.

Research limitations/implications

This study provides an interesting case of the firms' capacity to raise money during a crisis and that governance plays an important role in borrowing activities of firms. This will undoubtedly help motivating owners and policymakers for improving governance. The authors’ findings may be useful for policymakers to develop policies considering the adverse effects caused by exogenous shocks. This is crucial because the severity of GFC as a shock seems to change the macro and institutional environment that firms operate. While the authors properly address the research hypotheses using country governance data, future research may employ corporate governance data to attain firm-level results by testing two competing hypotheses.


There are several important areas where this study makes original contributions. First, while Tsoy and Heshmati (2019) focus on the dynamics of capital structure for only Korean firms, the authors extend the sample including eight East Asian countries considering the impact of country governance on capital structure policy. Specifically, this study is the first in using the robust country governance data, which differs by country and year, in the crisis context. Next, the authors investigate both the AFC and GFC to compare whether these two crises have different effects on capital structure policy of East Asian firms. Finally, the authors aim to understand whether leverage is used as a substitute for governance or an outcome of governance mechanism considering recessions.



The authors thank the anonymous referees who have given detailed feedback to develop this paper.

Funding: The authors received no financial support for the research, authorship and/or publication of this article.


Tekin, H. and Polat, A.Y. (2023), "Is leverage a substitute or outcome for governance? Evidence from financial crises", International Journal of Emerging Markets, Vol. 18 No. 4, pp. 1007-1030.



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