Firm Characteristics, Corporate Governance and Financial Leverage: A Critical Literature Review

Abstract

This study is a critical review of the literature that seeks to establish the effects of firm characteristics, corporate governance (CG), firm performance, and macroeconomic environment on financial leverage. For this review, firm characteristics is assessed as firm size, age of the firm, and ownership structure. Corporate governance is assessed as directors' board size, the audit committee, and the CEO duality. Firm performance which is the intervening variable is determined through Return on Assets (ROA) and Return on Equity (ROE). The moderating variable, macroeconomic environment is determined as Gross Domestic Product (GDP), inflation rate, interest rate and exchange rate. While financial leverage is evaluated using the total debt to total asset ratio. The reviewed literature includes both theoretical and empirical data. The methodology used reviewed various empirical literature, articles, publications, and conceptual studies where descriptive and quantitative analysis were applied. According to various publications reviewed, there are positive, negative, and contradictory outcomes between firm characteristics, CG, firm performance and macroeconomic environment on financial leverage. Disparities in research methodology explain several inconsistent conclusions even in research with very comparable designs. Some studies show positive associations between board size, audit committee, CEO duality, company size, leverage, and profitability. However, other studies show that the level of CG is linked negatively to board size, leverage, and firm age. Other studies suggested that some form of CG mechanism and firm-specific characteristics, predominantly executive compensation, firm performance and firm leverage can impact the bearing and magnitude of the frequency of financial restatement. Nevertheless, in other studies, the timeliness of financial leverage was negatively impacted by the size of the company. Besides, the findings from a different strand of studies in the literature suggest that board ownership and audit quality negatively influence financial leverage. Other research gaps emerging in the literature review include; firm characteristics regarded as a moderating variable between corporate governance and financial leverage.  An unspecified possibility of dual causality exists between firm characteristics and corporate governance. The study suggests future research efforts based on the empirical specifications to fill knowledge gaps by taking into account the causality relationships of firm characteristics and corporate governance. The foregoing study is guided by key theories of CG including; stewardship, agency, stakeholder, and resource dependency (RDT) and recommends further research in firm characteristics, CG and financial leverage. Entrenched in research, financial leverage can be enhanced by providing good CG practices, and that macroeconomic environment theoretically moderates the relationship that exists between firm characteristics, CG and financial leverage. It is suggested that a similar study should be done, where future researchers may introduce other variables other than; firm performance and macroeconomic environment to examine the association of firm characteristics, CG and financial leverage.

Keywords: Firm Characteristics, Corporate Governance, Financial Leverage