The Role of Law and Trust in Corporate Financial Policies


Student thesis: Doctoral Thesis

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Award date13 Jul 2022


While formal institutions are considered important in affecting corporate behaviors, little attention has been paid to the role of informal institutions in such relations. This research employs the (formal) corporate governance reforms and (informal) individual countries’ trust levels to examine how the informal institution moderates the impacts of the formal institution on corporate policies. Using a difference-in-differences (DiD) research design, I document a positive effect of corporate governance reforms on external financing and investment. I also document a positive effect of trust on external financing and investment. More importantly, I find that the positive effect of formal regulatory reforms is decreasing with informal country-level trust. These findings are robust to an array of robustness tests including using alternative measures of trust, using alternative measures of corporate financial policies, controlling for potential confounding regulatory changes and several country-level characteristics, using propensity score matching (PSM), and using alternative approaches to address bias inherent in staggered difference in differences (DiD) estimations. The results from firm-level cross-sectional tests indicate that the reforms and trust have a stronger effect for financially constrained firms. Finally, I find that the adoption of corporate governance reforms is associated with a lower cost of debt and lower over- and under-investment, and the effect is amplified for firms domiciled in low-trust countries. These results suggest that institutional enhancement (via strengthened firm-level governance practices) and trust effectively alleviate the agency cost of capital accumulation and allocation. My study highlights that corporate governance and trust are substitutes, which implies a condition under which government intervention is optimal and indicates that countries can offset the negative lack-of-trust effect on economic outcomes through formal regulatory reforms.

    Research areas

  • Corporate Governance, Trust, Information Asymmetry, Corporate Finance, Investment