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Abstract
Serious corporate governance problems may lead to overborrowing by firms in a weak institutional environment. However, improvements in governance can help increase leverage when access to credit has been constrained. The relationship between governance and leverage also has a medium-term dimension: firms facing a significant debt overhang because of past overborrowing pass up profitable investment opportunities (Bris and Koskinen, 2002). The importance of governance to leverage decisions has macroeconomic implications—and this relationship may have an important impact on growth, particularly for industries that are most dependent on external finance (De Nicolo, Laeven, and Ueda, 2006). Moreover, economies with weak institutions may be prone to bigger contractions in output during crisis periods (Shimpalee and Breuer, 2006).
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