Determinants of internal governance quality: evidence from Sweden

Purpose – The purpose of this paper is to assess whether ownership concentration, leverage and demand for equity financing is associated with internal corporate governance quality. The paper focuses on dimensions of governance quality that are related to financial reporting quality. Design/methodology/approach – The authors measure internal governance quality by an indicator variable that takes on higher values depending on whether a company has an audit committee, has a sufficient number of audit committee meetings during the year, has financial expertise on the audit committee, has an internal auditing function, a risk management function, a code of conduct and whistle blower provisions in the code of conduct. The sample consists of 91 Swedish listed companies of which 39 companies had to follow the Swedish Corporate Governance Code. The development of hypotheses is based on agency theory. Ordered logistic regressions are used to test the hypotheses. Findings – The paper finds a strong negative association between leverage and the internal governance quality score for companies that do not have to follow the Corporate Governance Code. The paper also finds a positive association between the governance quality score and dispersed ownership among companies that have to follow the code. Research limitations/implications – The negative association between leverage and governance quality is opposite to the typical agency theory prediction. A number of other studies have also documented negative or insignificant associations with leverage in related settings. The research suggests there is a demand to develop theories related to leverage and the implementation of governance characteristics beyond the typical agency theory based predictions. Practical implications – The results raise the question whether lenders more actively directly or indirectly should influence the governance quality of borrowers. Originality/value – Based on the conjecture that governance quality increases with the number of governance elements, the paper studies a governance score that is built up by several elements of good corporate governance. Furthermore, the authors study a setting dominated by voluntary choices of governance quality, which makes it possible to study supply effects.