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Does Corporate Governance Matter More for High Financial Slack Firms?

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  • Kose John

    (Department of Finance, Stern School of Business, New York University, New York, New York 10012; Department of Finance, Fox School of Business, Temple University, Philadelphia, Pennsylvania 19122)

  • Yuanzhi Li

    (Department of Finance, Fox School of Business, Temple University, Philadelphia, Pennsylvania 19122)

  • Jiaren Pang

    (Department of Finance, School of Economics and Management, Tsinghua University, Beijing 100084, China)

Abstract

The effect of corporate governance may depend on a firm’s financial slack. On one hand, financial slack may be spent by managers for their private benefits; a high level is likely associated with severe agency conflicts. Thus corporate governance matters more for high financial slack firms (i.e., the wasteful spending hypothesis ). On the other hand, financial slack provides insurance against future uncertainties; a low level may signal deviations from the best interests of shareholders. Then corporate governance is more effective for low financial slack firms (i.e., the precautionary needs hypothesis ). We differentiate the two hypotheses using the passage of antitakeover laws to identify exogenous variation in governance. Consistent with the wasteful spending hypothesis, the laws’ passage has a larger negative impact on the operating and stock market performance of high financial slack firms. Further analysis shows that these firms do not invest more but become less efficient at cost management after the laws’ passage.

Suggested Citation

  • Kose John & Yuanzhi Li & Jiaren Pang, 2017. "Does Corporate Governance Matter More for High Financial Slack Firms?," Management Science, INFORMS, vol. 63(6), pages 1872-1891, June.
    • Handle: RePEc:inm:ormnsc:v:63:y:2017:i:6:p:1872-1891
    DOI: 10.1287/mnsc.2015.2392
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