Literature suggests a strong correlation between corporate governance and controlling bankruptcy risks. To understand the relationship the theory suggests studying the impact of corporate governance on debt. Corporate governance and strict bankruptcy laws affect the level of debt. Corporate governance negatively influences the cost of debt while its impact on the amount of debt is positive. Bankruptcy laws influence firms with poor corporate governance standards more than companies with efficiency standards. The lower level of corporate governance causes firms to suffer the consequences of bankruptcy laws. Poor corporate governance involves high bankruptcy risks while the study uncovers the role of corporate governance and bankruptcy on the variable of debt. The central factor that builds an association between the two variables is borrowing the power of the board members. The decision of the members regarding borrowing and crediting has direct impacts on bankruptcy risks. The findings indicate that the cost of debt does not depend on the audit committees depicting an independent relationship between two factors. Better corporate governance suggest lowers the cost of debt but the higher amount of debt. Other findings depict that effective corporate governance with strict bankruptcy laws lowers the risks of debt default. Protecting creditor’s interest also poses high risks in case of weaker corporate governance. Ownership structures, the board of directors and stakeholders have a significant influence on controlling bankruptcy risks (Funchal, Galdi, & Lopes, 2008).
Darat, Gray, and Park (2014) identify different factors of corporate governance that impacts bankruptcy risks. The study suggests that the variable of corporate governance are significant predictors of risks involved in the bankruptcy. The findings reveal a strong relationship between corporate governance and bankruptcy risks. Firms with larger boards are capable of declining risks of bankruptcy. The impact of corporate governance on bankruptcy risk increases with time. Changes in corporate governance increase risks of debt default. However, a strong association exists between efficient corporate governance involving the large board, effective structure, and policies with low bankruptcy risk (Darrat, Gray, & Park, 2016).
Wang and Ling (2010) explored the impact of corporate governance on risks of debt default. The assessment of previous studies depicted that corporate governance rules had significant non-linear impacts on bankruptcy risks. Negative association prevails between governance provisions and the likelihood of default as it provided opportunities for fending off to the managers. Conservative policy choice was the selection of managers that increased the risk factor. Managerial benefits of control are more likely to reduce the value of a firm that again contributes to increased risk of debt default. Strongest corporate governance declined the probability of risk while the weak governance resulted in increased default risk. The regulatory response has a direct relationship with the bankruptcy risk. Firm’s operational complexity increases due to increase in monitoring of optimal board resulting in high marginal benefits for the firm. Optimization of stakeholders value often results in high bankruptcy risks because they are more likely to change board that fails to maximize their gains. In such case, the risk of debt default will increase substantially. Effective corporate control policy manages internal conflicts through different tactics that minimize risks of bankruptcy. Poor judgments of decision makers and weak internal and external controls result in increased risks. A power-sharing relationship between corporate governance and stakeholders results in inefficient decisions. The rights of stakeholders have a correlation with equity value and they demand high value. Reduction in stakeholders rights acts in favor of efficient corporate governance that declines risks of debt default. The results depend on 201 cases of bankruptcy confirming a strong correlation between corporate governance and bankruptcy risks. Poor profitability of firms reflected weak corporate governance due to ineffective decision making that resulted in increased default risks (Wang & Lin, 2010).
Manzaneque, Priego, and Merino (2016) study the role of corporate governance including ownership and characteristics of the board on bankruptcy risks. The research design emphasized on 308 observations classifying them as distressed and non-distressed findings. The study identifies bankruptcy risk as a business failure and explores its relationship with corporate governance. The size of the board has a negative correlation with financial distress depicting low bankruptcy risks. Large board size minimizes the risks of a debt default that firm faces. The efficient audit committee is part of strong corporate governance that results in improved access to information and resources. The relationship between efficient audit committee and corporate governance exhibits positive impact of controlling bankruptcy risk. The results also depict the negative role of large stakeholders and their power on bankruptcy risk. The high power of stakeholders results in increased risks of debt default. High stakeholders power influence the decisions of board and audit committee resulting in weak corporate governance (Manzaneque, María, & Merino, 2016).
Chancharat (2013) determined how corporate governance influences bankruptcy risks and its association with company’s survival. The survival of the firm depends on controlling default risk. Companies having efficient corporate governance are able to minimize risks associated with bankruptcy thus improving the financial position. The prediction of financial distress and firms ability to manage bankruptcy risks depends on the performance of corporate governance. Corporate governance with large board lowers the threats of financial distress as they likelihood of efficient decision-making increases. Limited role of stakeholders in firms decisions also minimizes default risks that enhance survival opportunities of the firm. The findings also reveal the negative role of stakeholders interest in controlling decisions of the board and managers. Increased involvement of stakeholders increases risks of the debt default that declines chances of firms survival (Chancharat & Chancharat, 2013).
Wang, C.-J., & Lin, J.-R. 2010, Corporate Governance and Risk of Default. IBF , 3 (2), 1-27.
Chancharat, S., & Chancharat, N. 2013, Corporate Governance and Company Survival. Journal of Social Sciences, Humanities, and Arts, 13 (1).
Darrat, A. F., Gray, S., & Park, J. C. 2016, Corporate Governance and Bankruptcy Risk. Journal of Accounting, Auditing & Finance, 31 (2).
Funchal, B., Galdi, F. C., & Lopes, A. B. 2008, Interactions between Corporate Governance, Bankruptcy Law and Firms’ Debt Financing: t Law and Firms’ Debt Financing: the Brazilian Case. BAR, Curitiba, 5 (3), 245-259.
Manzaneque, M., María, A., & Merino, P. E. 2016, Corporate governance effect on financial distress likelihood: Evidence from Spain. Revista de Contabilidad , 19 (1).