Economics of Governance

, Volume 18, Issue 1, pp 35–70 | Cite as

Democracy, rule of law, and corporate governance—a liquidity perspective

Original Paper

Abstract

This study examines whether and how democracy and rule of law—two overarching country-level governance variables—influence corporate governance. Given that corporate liquidity (cash holdings) is a good channel for examining the quality of corporate governance, the effects of democracy and rule of law on corporate governance can be identified using the liquidity approach. A review of 67 countries from 1996 to 2010 demonstrates that democracy and rule of law indeed have bearings on corporate governance. More specifically, results indicate that firms are more inclined to hoard cash to take advantage of growth opportunities when the level of democracy is higher or rule of law is stronger, suggesting that agency costs are lower and interests of managers and shareholders are more aligned under such circumstances. In addition, the negative effect of debt issuance and dividend payment on cash is more pronounced when the level of democracy is higher or rule of law is stronger, suggesting that these two approaches become more effective in reducing agency costs and transitively cash holdings under such circumstances. Moreover, the positive effect of democracy and rule of law on corporate governance appears to be reinforced when rule of law is stronger and the level of democracy is higher, respectively. Furthermore, higher level of economic development helps reap the benefit of democracy and rule of law in terms of improving corporate governance and reducing agency costs.

Keywords

Democracy Rule of law Corporate governance Corporate liquidity Cash holding 

JEL Classification

A12 G30 G38 O10 P16 

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Copyright information

© Springer-Verlag Berlin Heidelberg 2016

Authors and Affiliations

  1. 1.International Institute for Financial ResearchJiangxi Normal UniversityNanchangChina
  2. 2.Department of FinanceNational Chung Cheng UniversityMin-Hsiung TownshipTaiwan

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