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Abstract
We investigate whether corporate governance aects rms credit ratings and
whether improvement in corporate governance standards is associated with
improvement in investment grade rating. We use the Gov-score of Brown and
Caylor (2006), the Gompers G index and an entrenchment score of Bebchuk
et al. (2009) to proxy for corporate governance. Using a sample of US rms, we
nd that rms characterized by stronger corporate governance have a signicantly higher credit rating, and that this association is accentuated for smaller
rms relative to larger rms. We nd that an improvement in corporate governance is associated with improvement in bond rating.
Key words: Corporate governance; Credit ratings; Changes in corporate
governance; Changes in credit ratings
JEL classication: G24, G32, G34
doi: 10.1111/j.1467-629X.2010.00396.x
1. Introduction
In this study, we use the methodology developed by Ashbaugh-Skaife et al.
(2006) to examine the inuence of corporate governance on a rms credit
ratings. The issue of corporate governance has become more important because
of the highly publicized nancial reporting frauds at Enron, Worldcom and
Parmalat (Palmrose and Scholz, 2004). One of the most important functions of
We are grateful to the anonymous reviewers and the editors for their helpful comments
on the paper.
Received 31 August 2009; accepted 16 December 2010 by Robert Fa (Editor).
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The entrenchment index is based on six provisions; staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes and super majority requirements for mergers and charter amendments.
293
294
The above discussions suggest that, in the presence of higher levels of corporate governance, the exibility of managers to act in their own self-interest is limited, resulting in more eective decision making and higher rm performance.
Indeed, Fitch Ratings (2004) emphasizes the importance of corporate governance in the rating process. Strong governance structures and practices improve
the reliability and validity of the reported accounting numbers used by rating
agencies in assessing a rms likelihood of default (Ashbaugh-Skaife et al., 2006).
This leads to our two related hypotheses stated as follows:
H1: Higher level of corporate governance is associated with higher credit ratings.
H2: Improvement in levels of corporate governance leads to improvement in credit
ratings.
3. Research design and sample selection
3.1. Model specication and variable denitions
To test our rst hypothesis, we estimate the following logistic regression:
Model 1.
X
CREDITRATING b0 b1 GOV SCORE
bj Control Variablesj e:
j
The credit ratings data used in our study were based on the long-term issuer
credit ratings compiled by Standard and Poors. The Standard and Poors ratings
range from AAA (highest rating) to D (lowest rating debt in payment default).
We measured credit rating in two ways following Ashbaugh-Skaife et al. (2006).
We rst created an indicator variable, INVSTMENT_GRADE, representing 1 if
the credit rating was, AAA, AA+, AA), A+, A, A) BBB+ and BBB); 0 otherwise. A rm is considered an investment grade if coded 1 and a speculative grade
if coded zero. A logistic regression model is estimated using this two-category
classication scheme. To increase the robustness of our results and to further test
the predicted relations between corporate governance and credit ratings, we also
estimated an ordered logit model (CREDIT_RATING). The ordered logit model
(also referred to as proportional odds model) is a regression model for ordinal
dependent variables and an extension of the logistic regression model for dichotomous dependent variables.2 We use ordered logit regression (OLR) because we
have dierent categories of credit ratings. As mentioned, OLR is an extension of
2
The model makes the proportional odds assumption: the odds ratio for being in a chosen
category or higher compared to being in a lower category is the same regardless of which
category is chosen. This implies that if the ordinal variable were collapsed into two categories, the odds ratio would be the same regardless of the cut-o chosen for the collapsing.
295
the logistic regression model for dichotomous dependent variable allowing for
more than two ordered response categories and is recommended as the most
appropriate technique (Ashbaugh-Skaife et al., 2006) when the dependent variable has multiple values that can be ordered from low to high. For the dependent
variable of the ordered logit model, we collapsed the multiple ratings into seven
categories of credit ratings, which convey ordinal risk assessments. Each category
is mapped into a range of credit ratings as follows:
Rating category 1: D, C, CC, CCC, CCC+
Rating category 2: B), B, B+
Rating category 3: BB), BB, BB+
Rating category 4: BBB), BBB, BBB+
Rating category 5: A), A, A+
Rating category 6: AA), AA, AA+
Rating category 7: AAA
Our independent variable of primary interest was GOV_SCORE, which is
measured using the governance score developed by Brown and Caylor (2006).
We also had a number of control variables that could aect the default risk (and
hence, credit rating) of a rm. We subsequently use a number of control variables that have been used in the literature to surrogate or act as proxy for a
rms default risk. These are as follows:
3.1.1. Leverage (LEV)
Leverage of a rm proxies for default risk because the higher the proportion
of debt in its capital structure, the greater the probability the rm could nd difculty in paying o its creditors, (Ashbaugh-Skaife et al., 2006; Bhojraj and
Sengupta, 2003). Thus, we expect a negative relationship between a rms leverage and credit ratings. Leverage is measured as total debt divided by total assets.
3.1.2. Firms operating loss (LOSS)
When a rm incurs operating losses, the chances of paying o creditors could
diminish (Ashbaugh-Skaife et al., 2006). This is measured as a dummy variable
representing 1 if the net income before extraordinary items is negative in the
current year; 0 otherwise. The coecient of LOSS is expected to be negative.
3.1.3. Times interest ratio (INTCOVR)
This ratio indicates the ability of a company to pay o the interest due on its
debt. The lower this ratio, the greater the diculty in paying o interest and
hence a higher default risk (Ashbaugh-Skaife et al., 2006; Bhojraj and Sengupta,
2003). Thus, we expect a positive relationship between INTCOVR and credit
2011 The Authors
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297
In our study, the cross tabs show many cells either empty or very small so that an ordinal logistic or multivariate logistic model would bias the results. The use of marginal
eects is appropriate as it is a common test used to determine the economic signicance in
economics research.
We standardize each non-binary variable by its mean and dividing by its standard deviation. Since the variables in our model are measured in dierent units, standardization
facilitates the interpretation of our results.
298
Table 1
Variable Denitions
Variable
Denition
INVSTMENT_GRADE
CREDIT_RATING
GOV_SCORE
HG
MG
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETA
299
300
Table 2
Descriptive Statistics (N = 2628)
Variable
Dependent Variable
INVSTMENT_GRADE
CREDIT_RATING
Independent Variable
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETAV
GOV_SCORE
HG
MG
Mean
Median
0.6123
3.7881
0.4862
0.0462
0.1221
12.893
0.1693
22.268
0.647
3.5747
2.9484
1.2247
30.034
0.3204
0.2842
1
4
0.4725
0.0436
0
6.9279
0
22.147
0.5874
3.105
2.2796
1.1205
31
0
0
25th Pctl
0
3
0.3918
0.0215
0
3.9942
0
21.284
0.3377
)0.84
1.6279
0.8212
25
0
0
75th Pctl
1
4
0.569
0.0742
0
13.328
0
23.198
0.9388
8.945
3.4382
1.5309
35
1
1
SD
0.4873
1.0638
0.1431
0.0586
0.3275
19.267
0.3751
1.2616
0.386
10.788
3.5593
0.5748
5.7427
0.4667
0.4511
INVSTMENT_GRADE equals one if rms credit rating is investment grade, and zero otherwise.
CREDIT_RATING is the ordinal ranking of the S&P LT Domestic Issuer Credit Rating (Compustat no. 280). GOV_SCORE = Corporate Governance Score computed based on Brown and Caylor
(2006); HG = one if GOV_SCORE 34, and zero otherwise; MG = one if 29 GOV_
SCORE 33, and 0 otherwise; LEV = total debt (Compustat no. 9 plus Compustat no. 34) divided
by total assets (Compustat no. 6); ROA = net income before extraordinary items (Compustat no.
18) divided by total assets (Compustat no. 6); LOSS = one if the net income before extraordinary
items is negative in the current and prior scal year, zero otherwise; INTCOVR = operating income
before depreciation (Compustat no. 13) divided by interest expense (Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt, zero otherwise (Compustat no.
80); SIZE = natural log of total assets; CAPINTEN = Gross PPE (Compustat no. 7) divided by
total assets; CUMRET = cumulative daily stock return over year t; MVBV = the market value of
equity calculated as (Compustat no. 199) multiplied by the number of shares outstanding (Compustat
no. 25); divided by the book value of equity at the end of period (Compustat no. 60); BETA = the
equity beta obtained from CRSP, (data item: BETAV). All continuous variables are winsorized at
the top and bottom 1%.
)0.284
0.430
)0.389
0.519
)0.370
0.511
)0.008
0.017
0.307
)0.444
0.180
1
)0.289
0.257
)0.489
0.190
)0.069
)0.075
)0.040
0.050
0.045
)0.064
)0.286
1
)0.567
0.755
)0.153
0.046
)0.120
0.107
0.513
)0.165
0.137
0.298
)0.657
1
)0.426
0.036
)0.113
0.085
)0.145
)0.211
0.229
)0.116
0.449 )0.398
)0.319
0.880
)0.274
0.341
)0.357
0.434
)0.424
0.477
0.022
0.012
0.206
)0.401
0.170
0.350 )0.357
)0.282
0.820
)0.395
0.410
)0.188
1
)0.279
0.117
)0.152
0.056
0.460
)0.134
0.163
0.336
0.225
0.197
)0.136
0.036
)0.162
1
)0.173
)0.082
0.059
)0.112
0.124
)0.109
)0.336
)0.424
)0.108
0.093
)0.119
0.095
)0.170
1
0.062
)0.024
0.111
)0.238
0.267
)0.051
)0.075
0.086
)0.125
)0.048
0.042
1
0.034
)0.135
0.007
)0.014
0.523 )0.047
)0.036
0.065
)0.104
)0.022
0.030
)0.034
0.059
1
0.130
0.022
)0.188
0.010
0.006
0.099
0.325
)0.166
0.178
)0.098
0.069
)0.058
0.018
1
)0.071
0.156
0.053
)0.191
0.271
)0.055
0.101
)0.207
0.040
0.017
)0.088
1
0.010
0.219 )0.451
0.149 )0.420
)0.071
0.134
)0.120
0.077
)0.111
0.276
)0.029
)0.127
0.091
)0.012
1
0.186
0.172
GOV_
CAPINTEN CUMRET MVBV BETAV SCORE
0.470 )0.008
ROA
Pearsons correlation coecients are reported in the upper Triangle, and Spearmans Correlation Coecients are reported in the bottom Triangle.
GOV_SCORE = Corporate Governance Score computed based on Brown and Caylor (2006); LEV = total debt (Compustat no. 9 plus Compustat no. 34)
divided by total assets (Compustat no. 6); ROA = net income before extraordinary items (Compustat no. 18) divided by total assets (Compustat no. 6);
LOSS = one if the net income before extraordinary items is negative in the current and prior scal year, zero otherwise; INTCOVR = operating income
before depreciation (Compustat no. 13) divided by interest expense (Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt, zero otherwise (Compustat no. 80); SIZE = natural log of total assets; CAPINTEN = Gross PPE (Compustat no. 7) divided by total assets;
CUMRET = cumulative daily stock return over year t; MVBV = the market value of equity calculated as (Compustat no. 199) multiplied by the number
of shares outstanding (Compustat no. 25); divided by the book value of equity at the end of period (Compustat no. 60); BETA = the equity beta obtained
from CRSP, (data item: BETAV). Bold correlation coecients indicate signicance at the 1% level. All continuous variables are winsorized at the top and
bottom 1%.
INVSTMENT_
GRADE
CREDIT_
RATING
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETA
GOV_
SCORE
INVSTMENT_ CREDIT_
GRADE
RATING LEV
Table 3
Pearsons and Spearmans Correlation Coecients
302
Table 4
Logistic regression results of the eects of corporate
governance score on rms Credit Ratings
P
CREDITRATING b0 b1 GOV SCORE j bj ControlVariablesj e
Dependent Variable =
INVSTMENT_GRADE
Predicted
Sign
Intercept
GOV_SCORE
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETA
Year Indicators
Industry Indictors
Pseudo-R2
Likelihood v2
Wald v2
Sample size
?
+
)
+
)
+
)
+
+
?
)
)
Dependent Variable =
CREDIT_RATING
Coe.
P > v2
Coe.
)26.62
0.0844
)4.898
15.766
)1.127
0.0098
)2.797
1.3658
0.1161
)0.002
0.0146
)1.862
Included
Included
0.5353
2013.8
602.08
2,628
<0.0001
<0.0001
<0.0001
<0.0001
<0.0001
0.0634
<0.0001
<0.0001
0.5827
0.7211
0.4769
<0.0001
Not reported
0.0471
<0.0001
)2.672
<0.0001
11.114
<0.0001
)1.019
<0.0001
0.0155
<0.0001
)1.367
<0.0001
0.9853
<0.0001
0.0366
0.7819
0.0003
0.9299
0.054
<0.0001
)1.435
<0.0001
Included
Included
0.6274
2594.4
<0.0001
1614.4
<0.0001
2,628
<0.0001
<0.0001
P > v2
Bold indicates governance variable(s) of interest. INVSTMENT_GRADE equals one if rms credit
rating is investment grade, and zero otherwise. CREDIT_RATING is the ordinal ranking of the
S&P LT Domestic Issuer Credit Rating (Compustat no. 280). GOV_SCORE = Corporate Governance Score computed based on Brown and Caylor (2006); LEV = total debt (Compustat no. 9 plus
Compustat no. 34) divided by total assets (Compustat no. 6); ROA = net income before extraordinary items (Compustat no. 18) divided by total assets (Compustat no. 6); LOSS = one if the net
income before extraordinary items is negative in the current and prior scal year, zero otherwise;
INTCOVR = operating income before depreciation (Compustat no. 13) divided by interest expense
(Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt,
zero otherwise (Compustat no. 80); SIZE = natural log of total assets; CAPINTEN = gross PPE
(Compustat no. 7) divided by total assets; CUMRET = cumulative daily stock return over year t;
MVBV = the market value of equity calculated as (Compustat no. 199) multiplied by the number of
shares outstanding (Compustat no. 25); divided by the book value of equity at the end of period
(Compustat no. 60); BETA = the equity beta obtained from CRSP, (data item: BETAV). All
continuous variables are winsorized at the top and bottom 1%.
303
304
Table 5
Marginal changes in probabilities of receiving an investment grade credit rating dependent variable:
INVSTMENT_GRADE (N = 2628)
GOV_SCORE
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETA
Expected
sign
Marginal eect
at individual obs.
Marginal eect
at mean values
?
)
+
)
+
)
+
+
?
)
)
0.0428***
)0.0619***
0.0817**
)0.0996**
0.0166*
)0.2473***
0.15236***
0.00396
)0.0023
0.00458
)0.0946**
0.0489***
)0.0588***
0.0695***
)0.1047***
0.0061*
)0.2495***
0.1526***
)0.0062
)0.0092
0.0051
)0.0948***
Bold indicates governance variable(s) of interest. The marginal eect represents the change in probability of receiving an investment grade credit rating because of a one standardized unit change in the
variable of interest. The marginal eect of variable Xi is computed as: p(X)/ xi = bip(X)[1 ) p(X)]
where bx is evaluated either 1) at individual observations and averaged across the sample, or 2) at
mean values of X, Greene (2003). *,**,*** indicates statistical signicance at the 1%, 5% and 10%
level or better, respectively. INVSTMENT_GRADE equals one if rms credit rating is investment
grade, and zero otherwise. GOV_SCORE = Corporate Governance Score computed based on
Brown and Caylor (2006); LEV = total debt (Compustat no. 9 plus Compustat no. 34) divided by
total assets (Compustat no. 6); ROA = net income before extraordinary items (Compustat no. 18)
divided by total assets (Compustat no. 6); LOSS = one if the net income before extraordinary items
is negative in the current and prior scal year, zero otherwise; INTCOVR = operating income
before depreciation (Compustat no. 13) divided by interest expense (Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt, zero otherwise (Compustat no.
80); SIZE = natural log of total assets; CAPINTEN = Gross PPE (Compustat no. 7) divided by
total assets; CUMRET = cumulative daily stock return over year t; MVBV = the market value of
equity calculated as (Compustat no. 199) multiplied by the number of shares outstanding (Compustat
no. 25); divided by the book value of equity at the end of period (Compustat no. 60); BETA = the
equity beta obtained from CRSP, (data item: BETAV). All continuous variables are winsorized at
the top and bottom 1%.
signicant implications for assessing a rms credit rating and that improvement
in GOV_SCORE is associated with improvement in credit ratings. This result
supports our H2. In addition, the results for the other variables with respect to
coecient signs and signicance remained the same including the coecient of
INTCOVR, which is positive and signicant at P-value 0.06 level.
5. Additional analyses
In this section, we conduct additional analyses to examine the role of the governance mechanism in explaining rms credit ratings. The raw GOV_SCORE used
2011 The Authors
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in our main analysis is an ordinal measure. Bebchuk et al. (2009) notes that using
the raw score measures imposes a linearity constraint on the ordinal
measures.6 This constraint may or may not be appropriate. We therefore perform
a second set of analyses by relaxing this constraint. More specically, we split our
sample into three levels of corporate governance. We dene HG (strong corporate
governance) to take on the value of 1 if GOV_SCORE 34, and 0 otherwise,
while MG (medium corporate governance) takes on the value of 1 if 29 GOV_
SCORE 33, and 0 otherwise. Our choices for interval width are designed to capture unambiguously the high, medium and low levels of the governance factor.
Roughly, 32 per cent of the rms are classied as having strong corporate governance regimes, 28 per cent as having weak corporate governance.7 Using the partitioning scheme, we estimate the following logistic regression model:
Model 3.
CREDITRATING b0 b1 HG b2 MG
X
j
bj Control Variablesj e
3
where HG and MG represent the partitioning indicator variables dened previously, and all other variables are as dened in Model 1. As specied, the model
also allows us to estimate the incremental eect of the level of corporate governance on rms credit ratings. The results are reported in Table 6.
Table 6 presents the regression analyses for the partitioned corporate governance. In the column where INVSTMENT_GRADE is the dependent variable,
the coecients on HG and MG are 0.8814 and 0.1467, respectively, but the
Specically, it would implicitly assume that the quantitative eect of going from, for
example, a low score (LG) to a medium score (MG) is the same as the quantitative eect
of going from a medium score (MG) to a high score (HG). There is no particular reason
that this should be the case. In other words, using the raw score implicitly imposes a linear restriction on the relation between the level of credit ratings and the Gov-score. By
partitioning our sample using indicator variables, we relaxed this constraint, and let the
data determine whether the eect of moving from LG to MG is the same as moving from
MG to HG.
We use alternative denition of HG and MG using the 75th and 25th quartiles. That is,
HG is dened as one if a rm has a GOV_SCORE of 35 or higher and zero otherwise.
We redene MG to take on the value of 1 if 25 Gov-Score 35, and 0 otherwise. We
nd that the coecient of HG is positive and signicant at the 1per cent level and that the
coecient of MG is positive and signicant at the 1 per cent level but the magnitude of
the coecient of HG (1.02) is more than twice as large compared to the coecient of MG
(0.45). In the OLR model, the coecient of MG is positive and signicant at 5 per cent
level, while the coecient of HG is positive and signicant at the 1 per cent level. The
magnitude of the coecient of HG is more than twice higher than the coecient of MG.
These results further support that only truly strong corporate governance is associated
with higher credit ratings.
306
Table 6
Logistic regression results of the eects of high and
P medium governance scores on rms credit ratings CREDITRATING b0 b1 H Gb2 MG bj ControlVariablesj e
j
Dependent Variable =
INVSTMENT_GRADE
Intercept
HG
MG
LEV
ROA
LOSS
INTCOVR
SUBORD
SIZE
CAPINTEN
CUMRET
MVBV
BETA
Year Indicators
Industry Indictors
Pseudo-R2
Likelihood v2
Wald v2
Sample size
Dependent Variable =
CREDIT_RATING
Predicted sign
Coe.
P > v2
Coe.
?
?
?
)
+
)
+
)
+
+
?
)
)
)25.23
0.8814
0.1467
)4.809
15.407
)1.149
0.0106
)2.798
1.3922
0.1498
)0.002
0.0189
)1.848
Included
Included
0.5347
2010.5
600.19
2628
<0.0001
<0.0001
0.4349
<0.0001
<0.0001
<0.0001
0.0464
<0.0001
<0.0001
0.4765
0.8172
0.3633
<0.0001
Not reported
0.5434
0.3611
)2.695
11.086
)1.01
0.0156
)1.374
0.9952
0.0544
0.0006
0.0562
)1.44
Included
Included
0.6268
2590.3
1611.9
2628
<0.0001
<0.0001
P > v2
<0.0001
0.0716
<0.0001
<0.0001
<0.0001
<0.0001
<0.0001
<0.0001
0.6807
0.8704
<0.0001
<0.0001
<0.0001
<0.0001
Bold indicates governance variable(s) of interest. INVSTMENT_GRADE equals one if rms credit
rating is investment grade, and zero otherwise. CREDIT_RATING is the ordinal ranking of the
S&P LT Domestic Issuer Credit Rating (Compustat no. 280). HG = one if GOV_SCORE 34, and
zero otherwise; MG = one if 29 GOV_SCORE 33, and 0 otherwise; LEV = total debt (Compustat no. 9 plus Compustat no. 34) divided by total assets (Compustat no. 6); ROA = net income
before extraordinary items (Compustat no. 18) divided by total assets (Compustat no. 6); LOSS = one if the net income before extraordinary items is negative in the current and prior scal year,
zero otherwise; INTCOVR = operating income before depreciation (Compustat no. 13) divided by
interest expense (Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt, zero otherwise (Compustat no. 80); SIZE = natural log of total assets; CAPINTEN = gross PPE (Compustat no. 7) divided by total assets; CUMRET = cumulative daily stock
return over year t; MVBV = the market value of equity calculated as (Compustat no. 199) multiplied by the number of shares outstanding (Compustat no. 25); divided by the book value of equity
at the end of period (Compustat no. 60); BETA = the equity beta obtained from CRSP, (data item:
BETAV). All continuous variables are winsorized at the top and bottom 1%.
307
to other categories of rms. While rms with the strongest corporate governance
have a high likelihood of receiving an investment grade credit rating or better
credit ratings, rms having moderately strong corporate governance may not.
Thus, although eorts by rms to strengthen their corporate governance are perceived favourably by rating agencies, only those rms adopting strong corporate
governance regimes achieve a signicant improvement in credit ratings. These
results provide additional insight into the relation between corporate governance
and credit ratings.
We also examine whether governance mechanisms have a dierential impact
on rms of dierent sizes. Small rms tend to be more risky. For high-risk rms,
traditional indicators such as past protability and debtequity ratio may not be
particularly informative about future cash ows. Small rms also have greater
information asymmetry relative to large rms and are perceived to have a higher
likelihood of withholding unfavourable information with regard to rm-specic
risk. Therefore, rating agencies would rely more on the rms governance structure such as the boards monitoring of management actions and oversight of the
nancial reporting process in evaluating the default risk for small rms. As a
result, higher corporate governance in small rms may be perceived more positively by rating agencies and thus have a relatively greater impact on these rms
credit ratings relative to larger rms.
To test whether rm size aects our results, we partition the rms in our sample into terciles based on rms scal year-end total assets. The large rms are
dened as those falling into the top tercile, and the small rms are those in the
bottom tercile. We ran separate regressions for the two subgroups, and
the results are reported in Table 7. Panel A presents the results using
INVSTMENT_GRADE as our rating measure. Similar to our main analysis, we
nd a positive association between the GOV_SCORE and INVSTMENT_
GRADE for both groups. However, while the coecient on the GOV_SCORE
is statistically signicant at the 0.01 level for the small rms, it is only marginally
signicant for the large rms (P-value = 0.085). In addition, the magnitude of
the coecient estimate for the small rms is more than twice that for the large
rms (0.1574 versus 0.0711). Panel B reports similar results for the regression
based on the CREDIT_RATING measure. These results lend support to our
conjecture that an increase in corporate governance has a greater eect (and
hence is more important) for smaller rms relative to larger rms. In addition,
we note that the control variables have the expected sign and signicance. Noteworthy is the coecient of INTCOVR that is marginally signicant in Panel A
for both small and large rms and is signicant at <0.001 in panel B.8
8
308
Table 7
Logistic regression results of the eects of corporate governance score on rms credit ratings for
subsamples based on rm size
Large*
Predicted
sign
Coe.
estimate
Small*
P > v2
Coe.
estimate
P > v2
309
Table 7 (continued)
Bold indicates governance variable(s) of interest. INVSTMENT_GRADE equals one if rms credit
rating is investment grade, and zero otherwise. CREDIT_RATING is the ordinal ranking of the
S&P LT Domestic Issuer Credit Rating (Compustat no. 280). GOV_SCORE = Corporate Governance Score computed based on Brown and Caylor (2006); LEV = total debt (Compustat no. 9 plus
Compustat no. 34) divided by total assets (Compustat no. 6); ROA = net income before extraordinary items (Compustat no. 18) divided by total assets (Compustat no. 6); LOSS = one if the net
income before extraordinary items is negative in the current and prior scal year, zero otherwise;
INTCOVR = operating income before depreciation (Compustat no. 13) divided by interest expense
(Compustat no. 15) or (Compustat no. 339); SUBORD = one if company has subordinated debt,
zero otherwise (Compustat no. 80); SIZE = natural log of total assets; CAPINTEN = Gross PPE
(Compustat no. 7) divided by total assets; CUMRET = cumulative daily stock return over year t;
MVBV = the market value of equity calculated as (Compustat no. 199) multiplied by the number of
shares outstanding (Compustat no. 25); divided by the book value of equity at the end of period
(Compustat no. 60); BETA = the equity beta obtained from CRSP, (data item: BETAV). *Large
indicates that rm size falls into the top tercile, and Small indicates that rm size falls into the
bottom tercile. All continuous variables are winsorized at the top and bottom 1%.
6. Robustness checks
6.1. Tests using additional surrogates for corporate governance
As mentioned, the GOV_SCORE has limitations. An important limitation
raised by Bebchuk et al. (2009) is that the kitchen sink approach might be misguided. They note that, among a large set of provisions, the provisions of real
signicance are likely to constitute only a limited and possibly small subset. As a
result, an index that gives weight to many provisions that do not matter, and as
a result underweighs the provisions that do matter is likely to provide a less accurate measure of governance quality than an index that focuses only on the latter.
Furthermore, when the governance index include many provisions, rms seeking
to improve their index rankings might be induced to make irrelevant or even
undesirable changes and might use their improved rankings to avoid making the
few small changes that do matter. To check the robustness of our results, we reran the regressions using the Gompers G-Score. The results corresponding to
Tables 4, 5 and 6 are not shown but available on request. The results using
the Gompers G-Score are consistent with the main results of the study. We also
re-ran the regressions using the Bebchuk et al. (2009) index.9 The results are still
consistent. However, we note that for the Bebchuk et al. index, data were only
available for the year 2004.10 Hence, owing to smaller sample size, the tests have
a limitation in that they lacked power.
9
For expediency, the results using the entrenchment index are not reported but are available on request.
10
The Risk Matrix database does not report governance variables in years 2003 and
2005, and as a result, our usable sample is small and results lack power.
2011 The Authors
Accounting and Finance 2011 AFAANZ
310
311
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