Corporate governance, financing patterns, and the cost of capital

In this paper, we examine the effects of corporate governance mechanisms on financing policies in a research setting where agency problems and external financing constraints are expected to be high and restrictive. Using a unique self-constructed corporate governance index and employing the Fama and French (1999) financing model of firms, we find that firms with weak corporate governance mechanisms have more leverage than do firms with strong governance mechanisms. After controlling for the effects among corporate governance components, we observe that firms with different levels of corporate governance quality use different corporate governance mechanisms in relation to their financing policies. Our results suggest that firms can dynamically adjust their leverage as a governance mechanism through compensation policy and shareholder rights