16co-Opted Boards and Capital Structure Dynamics

International Review of Financial Analysis 77 (2021) 101824
Contents lists available at ScienceDirect
International Review of Financial Analysis

journal homepage: www.elsevier.com/locate/irfa
Co-opted boards and capital structure dynamics

Theophilus Lartey, Albert Danso, Agyenim Boateng *
Leicester Castle Business School, De Montfort University, Leicester, UK
A R T I C L E I N F O A B S T R A C T
Keywords: This study examines the effects of co-opted directors and further tests the monitoring effectiveness of non-co-
Co-opted boards opted independent directors and co-opted independent directors on capital structure decisions. Employing a
Leverage large sample of 2548 US firms over the 1996–2015 period, we find strong evidence that co-opted boards exert a
Adjustment speed
positive and significant influence on firms' financial leverage. We also find that, whereas co-opted independent
Tax benefits
Financial crisis
directors are positively associated with financial leverage, non-co-opted independent directors have a negative
influence on a firm's leverage ratio, suggesting that co-option weakens the effective monitoring, thereby
increasing the firm's leverage ratio. Further analysis indicates that co-opted boards adjust towards target leverage
levels at a faster speed, with a half-life within a year for book and market leverage. Lastly, our results show that
the agency costs of managerial discretion and stockholder-bondholder conflicts arising from board co-option are
important drivers of financial leverage relative to tax incentives. Our results are robust to alternative measures of
board co-option, financial leverage, and endogeneity concerns.
1. Introduction and appointment of directors on capital structure choice. Yet, in prac

tice, CEOs have a significant role and influence in the selection of all
Prior evidence documents that firms with a high proportion of in board members, including non-executive directors (Knippen, Palar, &
dependent directors should suffer fewer agency problems that distort Gentry, 2018). Coles et al. (2014) pointed out that CEOs exert consid
corporate policy choices, while the converse may be the case for firms erable influence in the nomination process of board members and are
with a low proportion of independent directors (Chang et al., 2014; more inclined to select directors who share similar views or have social
Jensen & Meckling, 1976). Thus, the preference for an outsider- ties with them. As a result, it is argued that such directors may not
dominated board as an effective monitoring mechanism is rooted in impose stringent monitoring on a CEO, supporting the notion that di
agency theory, which posits that CEOs are self-serving and, if not rectors appointed with the CEO's involvement are likely to be co-opted,1
effectively monitored, may take decisions which may be detrimental to engendering agency conflicts between CEO and shareholders (Jiraporn
firm value (Jensen & Meckling, 1976). Board effectiveness measured as & Lee, 2018; Nguyen, 2012). The above argument appears consistent
a board which comprises a majority of independent directors is therefore with the conjecture by Morellec et al. (2012) and Chang et al. (2014),
widely documented to be an effective and important corporate gover who argue that agency conflicts may incentivise managers to adjust their
nance mechanism for optimal capital structure decisions (Balsmeier, leverage choices to their preferred targets to serve their personal in
Fleming, & Manso, 2017; Chang et al., 2014; Morellec, 2004). terests irrespective of the effect on shareholder wealth.
Grounded in the above argument, numerous studies over the past In this study, we attempt to examine how CEO involvement in the
decade have devoted enormous attention to the relationship between selection of corporate boards may influence board monitoring effec
corporate governance characteristics and capital structure decisions tiveness and capital structure decisions. More specifically, we examine
(Chang et al., 2014; Morellec, Nikolov, & Schürhoff, 2012). These the effects of board co-option on capital structure decisions and speed
studies have focused on board size, CEO duality and board indepen with which co-opted boards adjust the firm leverage to target level.
dence employing the traditional measure of board independence with Furthermore, we test the monitoring effectiveness of non-co-opted in
mixed results (Jiraporn & Lee, 2018). However, little systematic atten dependent directors and co-opted independent directors on capital
tion has examined explicitly the effects of CEO influence in the selection structure decisions. We do so by using a panel data approach on US firms
* Corresponding author at: Leicester Castle Business School, De Montfort University, The Gateway, Leicester LE1 9BH, United Kingdom.
E-mail address: [email protected] (A. Boateng).
1
Co-option is defined as the ratio of directors appointed after the CEO assumes office (Coles, Daniel, & Naveen, 2014)
https://doi.org/10.1016/j.irfa.2021.101824
Received 3 September 2020; Received in revised form 14 May 2021; Accepted 22 June 2021
Available online 25 June 2021
1057-5219/© 2021 Elsevier Inc. All rights reserved.
T. Lartey et al. International Review of Financial Analysis 77 (2021) 101824
over the sample period 1996–2015 to address the above research ob methodology. Section 4 discusses the empirical results and other
jectives. Employing a large sample of 2548 US firms, our evidence robustness tests. Section 5 summarises and outlines practical and theo
suggests that co-opted boards exert a positive and significant influence retical implications of the findings.
on firms' financial leverage. We also find that, whereas co-opted inde
pendent directors are positively associated with financial leverage, non- 2. Literature review and hypotheses development
co-opted independent directors have a negative influence on a firm's
leverage ratio, suggesting that co-option weakens the effective moni 2.1. Board monitoring: co-opted boards and capital structure policy
toring, thereby increasing the firm's leverage ratio. Further analysis in
dicates that co-opted boards adjust towards target leverage levels at a In the United States, corporate law mandates public firm operations
faster speed, with a half-life within a year for book and market leverage. to be steered by the board of directors (Eisenberg, 1976). Prior evidence
Our results also show that the agency costs of managerial discretion and suggests that firms usually appoint additional independent directors to
stockholder-bondholder conflicts arising from board co-option are comply with the mandate that necessitates a majority of independent
important drivers of financial leverage relative to tax incentives. Lastly, directors on the board (Balsmeier et al., 2017; Linck, Netter, & Yang,
the evidence suggests that increased uncertainty and vulnerability 2009). The board of directors is accorded the formal authority to ratify
during the financial crisis induced CEOs in co-opted firms to develop management initiatives, evaluate managerial performance, and punish/
strong risk aversion. reward management for non-achievement/achievement of desired tar
Our study makes several contributions to the extant literature. First, gets (Baysinger & Hoskisson, 1990; Fama & Jensen, 1983a). Thus, the
we extend the literature on the role of corporate boards, particularly, board of directors is a key component in the governance structure of a
board monitoring effectiveness in determining a firm's leverage choice. firm and play a critical role in monitoring management, safeguarding
Our findings suggest that board co-option leads to an increase in minority shareholders' rights, and advising top management (Fama &
leverage whereas non-co-opted independent directors reduce a firm's Jensen, 1983b; He & Luo, 2018). Organisation and finance literature
leverage ratio. The findings demonstrate that board co-option weakens contends that, by possessing these powers, boards set the foundations for
the monitoring effectiveness of the executive management, thereby managerial decision making (e.g., Chintrakarn, Jiraporn, Sakr, & Lee,
leading to suboptimal financial policies that may not maximise share 2016; Coles et al., 2014; Mizruchi, 1983). However, in practice, evi
holders' value. In contrast, non-co-opted independent directors appear dence suggests that boards may not be truly independent to effectively
to be effective monitors, which renders some support to the conclusion monitor the firm's operations because CEOs exercise considerable in
by Cole et al. (2014) that not all independent directors are effective fluence in the selection and appointment of the board members, making
monitors. the board ineffective and prone to agency problems. To gain a better
Second, our results support the agency explanation of capital struc understanding of the monitoring effectiveness of corporate boards, this
ture choice. Thus, our results that co-opted boards lead to increased study follows Coles et al. (2014) and focuses on the fraction of board
leverage ratios suggest that co-opted boards tend to exacerbate agency members appointed after the CEO assumed office. These board members
costs by weakening the boards' oversight role over executive manage are referred to as co-opted directors since they are more likely to show
ment which allows senior managers to make risky corporate financial allegiance to the CEO who appointed them. Therefore, boards with a
decisions that may affect shareholder value. Thus, this study therefore greater proportion of co-opted directors may tend to be ineffective
represents one of the first attempts to examine the extent to which board monitors.
co-option affects the monitoring effectives of the board and corporate As applied to capital structure decisions, weak quality of board
financing decisions. monitoring over executive management allows self-serving managers to
Third, and in contrast with other studies, we find that firms with co- adopt suboptimal capital structure policy to maximise their personal
opted boards adjust towards target leverage levels at a faster speed, with benefits (Chang et al., 2014). Thus, the connections or friendship ties
a half-life within a year for book and market leverage. Hence, our results between the directors and CEO may undermine the board's willingness
suggest that co-opted boards engender agency conflicts and may and capacity to monitor and oversee CEO behaviours (Fracassi & Tate,
incentivise managers to adjust their leverage choices at a faster speed to 2012; Wilbanks, Hermanson, & Sharma, 2017). Thus, the greater the
their preferred targets to serve their personal interests, irrespective of number of co-opted directors on the board, the more susceptible the
the effect on shareholder wealth. Thus, co-opted boards appear to be board is to agency problems. This is because co-option leads to a
responsible for the speed at which firms make their capital structure heightened sense of trust and favourable interpretation of others' ac
adjustment. tions. Thus, co-option may lead to familiarity bias and undermine the
Fourth, our additional analysis adds to the capital structure literature quality of board monitoring and directors' fiduciary responsibilities
by isolating the strategic effect of tax benefits and unused debt capacity (Bruynseels & Cardinaels, 2014; Linck, Netter, & Yang, 2008), including
from other potential non-strategic effects that could confound our co- board ineffectiveness in monitoring corporate strategy and key business
option inferences. We establish a tax channel of the trade-off and decisions (Fracassi & Tate, 2012; Westphal, 1999). From this perspec
agency theory under which accumulation of leverage reduces the firm's tive, we expect that, where a board consists of a larger number of co-
cost of capital, thereby lessening the competitive risk faced by the firm opted directors, the CEO is likely to adopt higher leverage policy, even
and the strategic benefit of unused debt capacity (Klasa, Ortiz-Molina, beyond the optimal level, to engage in activities designed to protect their
Serfling, & Srinivasan, 2018; O'Brien, 2003). In doing so, we demon job security (Berger, Ofek, & Yermack, 1997). Coles et al., 2014; Lim,
strate that the agency costs of managerial discretion and stockholder- Do, & Vu, 2020). Thus, board co-option may exacerbate the conflicts of
bondholder conflicts arising from board co-option are important interest between shareholders and managers, leading to poor corporate
drivers of financial leverage relative to tax incentives. financing choices. In line with the above discussions, we hypothesise
Lastly, we use the 2007/08 financial crisis as an exogenous shock that:
that may affect leverage to address any endogeneity issues. Given that
Hypothesis 1. Firms with a higher proportion of co-opted directors have
co-opted directors allow CEOs to adopt corporate policies that reflect the
greater leverage.
CEOs' own risk aversion, strong risk aversion may decrease firm distress
or risk through leverage reductions during the crisis periods (Danso
et al., 2019). This risk-averse nature of CEOs ensures that they under 2.2. Board independence: co-opted boards and capital structure policy
invest when firm vulnerability or uncertainty is high.
The rest of the paper proceeds as follows. Section 2 examines the The effectiveness of a board in fulfilling its oversight responsibilities
relevant literature and hypotheses. Section 3 describes the data and depends on how it is composed (Adams, Hermalin, & Weisbach, 2010).
2
Research evidence supports the contention that competent monitoring is Table 1

achieved by a board whose composition is dominated by independent Description of variables.
directors (Dalton, Daily, Ellstrand, & Johnson, 1998; Zahra & Pearce, Variables Description
1989). Thus, a board with a high proportion of independent directors
Independent Variables
may also bolster the credibility of the firm to outside investors, reduce Co-opted Directors Co-opted Directors is captured by the number of
the cost of capital and increase firm value. In short, the effectiveness of directors elected after the CEO assumes office or by
the board to make good policy choices such as capital structure decisions the incumbent CEO scaled by board size.
to achieve the desired corporate outcomes is driven by the nature of the Tenure-weighted Co-option Tenure-Weighted Co-option is the sum of the tenure
(Co-optionTW) of co-opted directors divided by the total tenure of all
board and its composition (i.e., independent or friendly). Seminal papers directors.
(e.g., Fama, 1980 and Fama & Jensen, 1983a), suggest that independent
Dependent Variables
directors are more effective at performing their role as advisors and
Net book leverage Net book leverage is measured as the summation of
monitors of the firm due to the stronger incentives to sustain their (NBLev) the book value of long-term debt (DLTT) and debt in
reputation. Moreover, the appointment of more independent directors current liabilities (DLC) minus cash holdings (CHE)
on a firm's board may lessen the severity of agency conflicts (Lim et al., divided by book value of assets (AT).
2020). Simply, firms with more independent boards are better moni Net market leverage Net market leverage is the book value of long-term
(NMLev) debt (DLTT) plus debt in current liabilities (DLC)
tored. However, not all independent directors may be equally effective
minus cash holdings (CHE) divided by market value
in their monitoring roles (Coles et al., 2014). In most cases, “co-opted of assets (PRCC_F*CSHO + AT − CEQ).
but independent” directors may behave in a similar fashion as non- Book leverage Book leverage and Market leverage are analogously
independent directors, whilst “non-co-opted and independent” di (BLev) defined, except that cash holdings are not subtracted
from total debt. (i.e., BLev = (DLTT + DLC)/AT)
rectors may be more effective monitors (Lim et al., 2020). For instance,
Market leverage Cash holdings are not subtracted from the numerator
Faleye (2015) shows that firms that have fully independent boards (MLev) − total debt. (i.e., MLev = (DLTT + DLC)/
where the CEO is the only employee director leads to a significant (PRCC_F*CSHO + AT − CEQ))
decrease in firm performance. Similarly, Cavaco, Crifo, Rebérioux, and
Roudaut (2017) found the effect of board independence on firm per Firm Controls
Firm size Firm size is the natural logarithm of the book value of
formance to be vague due to opposing forces relating to the director
Total Assets.
nomination process and board functioning. In a recent paper, Lim et al. Tobin’s Q Tobin’s Q is the market value of assets divided by the
(2020) argued that creditors perceive co-opted directors as weaker book value of assets. It proxies for growth prospects.
monitors and therefore increase the firm's loan covenant intensity, Return on assets Return on assets is the operating income before
(ROA) depreciation divided by the book value of assets. It
regardless of whether these directors are independent or non-
serves as a proxy for profitability and the availability
independent. If, indeed, lenders have such perceptions about co- of internal funds.
option, then we expect that a higher proportion of “non-co-opted and Asset Tangibility Tangibility is measured as the value of tangible assets
independent” directors will be associated with less leverage. At the same (Tangibility) scaled by total assets.
time, a higher proportion of co-opted directors (independent or non- Earnings volatility Earnings volatility is the standard deviation of a
firm’s return on assets over the previous five years
independent) should lead to greater debt accumulation. We therefore
(inclusion in the sample necessitates a firm to have at
test the conjecture that the effects of independent directors may vary least three years of data during the prior five years).
when making corporate financial choices. Therefore, we hypothesise Dividend Dividend is a proxy for whether a firm pays common
that: dividends (i.e. a variable equal to one if a firm pays
common dividends, and zero otherwise).
Hypothesis 2. Whereas firms with a higher proportion of co-opted inde Financial Constraint Financial constraint is measured as firm’s interest
pendent directors may have greater leverage, firms with a higher proportion of expenditures scaled by total assets. It proxies for a
firm's capabilities of obtaining loans.
non-co-opted independent directors have relatively less leverage.
Investment Investment is the net capital expenditure (capital
expenditure minus depreciation) divided by the book
3. Methodology value of total property, plant and equipment.
R&D Intensity The ratio of R&D expenditures to total turnover.
3.1. Data
Board & CEO Specific Controls
Board Size The natural logarithm of the total number of
We employ director data from the Institutional Shareholder Services directors on the board as at the end of the fiscal year.
(ISS) – (formerly RiskMetrics), executive data from ExecuComp, and CEO Duality Board Chair is an indicator variable equal to one if
financial/accounting data from the merged Center for Research in Se the CEO is also the chairperson of the board of
directors as at the end of the first fiscal year. The dual
curity Prices (CRSP)/Compustat database spanning the period 1996 to
role also proxies for CEO power as well as the
2015. We first match the CRSP/Compustat to ExecuComp's Annual difficulty and complexity of CEO’s job.
Compensation dataset on FYEAR-GVKEY. To guarantee accuracy, we CEO Compensation The natural logarithm of CEOs total compensation
further match the compiled dataset to other ExecuComp datasets on over the fiscal year. The sum of salary, bonus, total
YEAR, GVKEY, and EXECID. Further, we match FYEAR-GVKEY pairs value of restricted stock granted, total value of stock
options granted (estimated using Black-Scholes),
from the CRSP/Compustat database to ISS “Directors Legacy” (for data
long-term incentive payouts, and other
before 2008) and “Directors” dataset (for 2008 onwards). To stand a compensation.
chance of inclusion in the analysis, the following conditions must be CEO Tenure CEO tenure is the natural logarithm of number of
satisfied: the TIC from Compustat must equal the TICKER row from ISS; years the CEO has served in the position as at the end
of the fiscal year. It is an additional proxy for CEO
the first six digits of NCUSIP from CRSP row equals CN6 from the “Di
power.
rectors Legacy” dataset or equals the first six digits of CUSIP (after filling CEO Age Age is the natural logarithm of the CEO’s age as at the
it from the left with zeros such that it has nine digits) from the “Di end of the fiscal year.
rectors” dataset; FYEAR from Compustat equals YEAR row from ISS. Board Independence The board independence as the fraction of outside
Necessitating a match on both tickers and 6-digit CUSIPs mitigates issues directors on the board.
of duplication for any FYEAR-GVKEY pair against the ISS row. The The table presents the mnemonics and description of each dependent and in
initial sample of firm-year observations comprised 25,891 observations dependent variable used in this paper.
on 2548 firms. We further exclude financials (SIC codes 6000 to 6799),
3
Table 2
Descriptive statistics.
Mean S.D. Min. Max. 25th P 50th P 75th P Observations
Co-opted Directors 0.52 0.32 0.00 1.00 0.25 0.56 0.80 17092
Co-optionTW 0.68 0.33 0.00 1.00 0.49 0.82 0.96 17092
Co-opted - Indep 0.36 0.26 0.00 1.00 0.14 0.33 0.57 17091
NBLev 0.06 0.29 − 0.95 2.66 − 0.12 0.10 0.26 17004
NMLev 0.05 0.14 − 0.54 1.10 − 0.04 0.04 0.13 17002
BLev 0.21 0.18 0.00 2.93 0.06 0.20 0.32 17029
MLev 0.11 0.11 0.00 1.10 0.02 0.09 0.17 17007
Firm Size 7.45 1.49 2.86 13.59 6.38 7.30 8.39 17091
TobinQ 1.78 1.67 0.02 78.42 0.94 1.35 2.06 17007
ROA 0.14 0.11 − 1.69 1.18 0.10 0.14 0.19 17038
Tangibility 0.26 0.21 0.00 0.98 0.10 0.20 0.36 17061
Earnings vol 0.04 0.04 0.00 0.79 0.01 0.03 0.05 15115
Dividend 0.53 0.50 0.00 1.00 0.00 1.00 1.00 17092
Fin. Constraint 0.16 0.18 0.00 12.23 0.09 0.15 0.19 16976
Investment − 0.04 0.44 − 17.38 7.14 − 0.07 0.00 0.08 16920
R&D Intensity 0.05 0.07 0.00 1.13 0.00 0.03 0.07 11766
Board Size 4.12 0.13 3.50 4.55 4.03 4.11 4.20 15725
CEO Duality 0.86 0.35 0.00 1.00 1.00 1.00 1.00 15729
CEO Compensation 7.87 1.16 − 6.91 12.84 7.18 7.91 8.61 15429
CEO Tenure 1.74 0.76 0.00 3.14 1.39 1.79 2.30 15729
CEO Age 3.95 0.14 3.37 4.47 3.87 3.95 4.04 15705
Board Indep. 0.55 0.50 0.00 1.00 0.00 1.00 1.00 17092
Observations 17092
The table presents the summary statistics for all variables used in our core capital structure assessment in Table 4. All variable definitions are in Table 1.
utilities (SIC codes 4900 to 4949) and firms incorporated outside the where Xi, t− 1 is the set of one-year lagged firm-level variables from Eq.
United States, leaving us with a final sample of 17,092 firm-year (1), Cc, t− 1 is a specific one-year lagged industry-level factor, Xi, t− 1 × Cc,
observations.
t− 1 are the industry-firm interaction effects, and ωi is the firm-specific
effect. To control for time-varying executive and control conditions,
3.2. Estimation method we follow Coles et al. (2014) and include the one-year lagged Board size,
CEO age, CEO compensation and CEO tenure into the model.
We divide the analysis into two sections. First, we assess the According to the trade-off theory, β = 0, and the variation in Lev
importance of board co-option on financial leverage by employing the eragei, t**, is nontrivial. Substituting Eq. (3) into the partial adjustment
static model of firm leverage with time-invariant firm-level effects. specification Eq. (2) and solving for Leveragei, t yields the following
Specifically, we employed the following econometric model: specification:
Leveragei,t = α + βCo − optioni,t + βXi,t + ωi + μt + εi,t (1) Leveragei,t = βCo − optioni,t + (1 − λ)Leveragei,t− 1 + (λβ1 )Xi,t− 1 + (λβ2 )Cc,t− 1
+ (λβ3 )Xi,t− 1 × Cc,t− 1 + λωi + εi,t (4)

Where i denotes the ith firm and t denotes fiscal year. Leverage is the
firm-level measures of financial leverage as defined in Table 1, Co- Where λ is the adjustment coefficient, and (1 − λ) is the speed of
option is the measure of directors appointed by the incumbent CEO by adjustment. This dynamic panel model requires special treatment in
year t, X is the vector of the control variables employed in our analysis, α short panels to avoid a biased adjustment speed estimate (Baltagi, 2008;
and β are parameters, ωi is a firm-specific effect, and μt is a year fixed Öztekin & Flannery, 2012). We find similar results using the two-step
effect. All estimated standard errors are clustered at the firm level. system generalised method of moments (GMM) (Blundell & Bond,
It is argued that changes in market conditions and shocks to income 1998). Eq. (4) accounts for the potentially dynamic nature of the firm's
as well as new investments and business growth may push firms off their capital structure and its unobserved heterogeneity.
optimal capital structure levels. In an imperfect world with transaction
costs, it is very costly to promptly adjust the capital structure to the
3.3. Measurement of variables
optimal level (Myers, 1984). Rather, firms work their way back towards
their target capital structure over time (see, e.g., Flannery & Rangan,
3.3.1. Firm financial leverage
2006; Altuntas, Berry-Stölzle, & Wende, 2015). Thus, in the second part
For our dependent variable, Leverage, we used four key measures: (i)
of our analysis, we estimate a partial adjustment model of firm leverage:
Net book leverage, (ii) Net market leverage, (iii) Book leverage, (iv)
( )
Market leverage. This ensures that our results are robust and clearly
Leveragei,t − Leveragei,t− 1 = α + λ Leverage**
i,t − Leveragei,t− 1 + εi,t (2)
reflect the actual changes in financial leverage. Table 1 provides a
summary for measurement/definitions used in this study.
where Leveragei, t is the actual leverage of firm i in year t, Leveragei, t**
represents the sample average of the model described in Eq. (1) and can
3.3.2. Board co-option
be interpreted as the firm's target or desired leverage level and λ is the
Following Coles et al. (2014), our primary measure of Board co-
adjustment parameter (where 0 < λ < 1). Since firms' target leverage is
option is captured by the number of directors elected after the CEO as
unobservable, we model it as a function of observable firm-level factors,
sumes office or by the incumbent CEO scaled by board size.
interaction effects between the firm- and industry-level factors as well as
time-invariant firm-specific effects. Our econometric specification is Number of Co − opted directorsi,t
Co − option =
given below: Board sizei,t
Leverage**
i,t = βCo − optioni,t + β1 Xi,t− 1 + β2 Cc,t− 1 + β3 Xi,t− 1 × Cc,t− 1 + ωi
For robustness purposes, we also utilise the alternative measure of
(3) co-option, Tenure-Weighted Co-option (Co − optionTW). We capture this
as the sum of the tenure of co-opted directors divided by the total tenure
4
T. Lartey et al.
Table 3
Correlation matrix.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22
1 Co-opted Directors 1.00

2 Co-optionTW 0.94* 1.00
3 Co-opted-Indep 0.88* 0.79* 1.00
4 NBLev 0.08* 0.10* -0.10* 1.00
5 NMLev 0.05* 0.06* -0.07* 0.92* 1.00
6 BLev 0.04* 0.04* -0.05* 0.84* 0.82* 1.00
7 MLev 0.03* 0.04* -0.05* 0.79* 0.90* 0.88* 1.00
8 Size 0.09* 0.12* -0.02* 0.33* 0.29* 0.26* 0.23* 1.00
9 Tobin Q -0.05* -0.07* 0.03* -0.29* -0.23* -0.16* -0.32* -0.09* 1.00
10 ROA 0.02 0.02* -0.01 0.02 -0.03* -0.08* -0.20* 0.10* 0.32* 1.00
11 Tangibility 0.04* 0.04* -0.06* 0.37* 0.36* 0.23* 0.26* 0.12* -0.12* 0.13* 1.00
12 Earnings vol -0.04* -0.05* 0.02 -0.23* -0.19* -0.06* -0.08* -0.28* 0.17* -0.25* -0.02* 1.00
5
13 Dividend 0.12* 0.15* -0.08* 0.25* 0.19* 0.12* 0.07* 0.34* -0.08* 0.18* 0.15* -0.23* 1.00
14 Fin. Constraint -0.02* -0.02 0.02 0.02* 0.03* 0.04* 0.04* 0.06* -0.01 -0.12* -0.19* 0.00 -0.03* 1.00
15 Investment 0.02 0.02* -0.03* 0.07* 0.08* 0.02 0.01 0.06* 0.06* 0.14* 0.23* -0.10* 0.09* -0.06* 1.00
16 R&D Intensity -0.08* -0.09* 0.06* -0.43* -0.39* -0.19* -0.26* -0.26* 0.25* -0.37* -0.29* 0.45* -0.29* 0.09* -0.13* 1.00
17 Board Size -0.15* -0.15* 0.05* 0.08* 0.09* 0.06* 0.09* -0.13* -0.07* -0.06* 0.10* 0.05* 0.02 -0.01 0.03 -0.02 1.00
18 CEO Duality -0.02 -0.01 0.04* -0.01 -0.01 0.00 0.02 -0.02 -0.06* -0.04* -0.03* -0.02 -0.01 0.01 -0.05* 0.01 0.11* 1.00
19 CEO Compensation -0.01 0.00 0.05* 0.09* 0.06* 0.12* 0.05* 0.50* 0.07* 0.09* -0.07* -0.10* 0.10* 0.04* -0.02 -0.02 -0.03* 0.17* 1.00
20 CEO Tenure -0.14* -0.12* 0.18* -0.02 -0.03* -0.03 -0.04* 0.08* 0.02 0.04* -0.01 -0.05* 0.05* -0.03* -0.00 -0.02 0.17* 0.26* 0.15* 1.00
21 CEO Age -0.15* -0.14* 0.14* 0.05* 0.05* 0.03* 0.04* 0.02 -0.09* -0.02 0.03* -0.01 0.09* -0.02 -0.00 -0.09* 0.80* 0.12* 0.09* 0.27* 1.00
22 Board Indep. -0.04* -0.06* 0.06* -0.03* -0.02* 0.00 0.00 -0.05* -0.01 -0.02* -0.03* 0.02* -0.07* -0.02 -0.02* 0.04* 0.05* -0.00 -0.02 0.03* 0.02 1.00
The table presents the unconditional correlation coefficient between any pair of variables. All variables are as described in Table 1. * Indicates significance at 1%.

Table 4
Co-option on leverage.
NBLev NMLev BLev MLev
(1) (2) (3) (4) (5) (6) (7) (8)
Co-opted Directors 0.057*** 0.056*** 0.018*** 0.019*** 0.018*** 0.029*** 0.010*** 0.014***
(0.014) (0.013) (0.003) (0.006) (0.004) (0.009) (0.003) (0.004)
Firm Size 0.044*** 0.020*** 0.031*** 0.015***
(0.004) (0.002) (0.002) (0.001)
Tobin's Q − 0.030*** − 0.004** − 0.002 − 0.011***
(0.006) (0.002) (0.004) (0.002)
ROA − 0.140* − 0.092*** − 0.262*** − 0.175***
(0.078) (0.028) (0.056) (0.025)
Tangibility 0.508*** 0.194*** 0.138*** 0.082***
(0.042) (0.018) (0.028) (0.015)
Earnings vol − 0.196 − 0.107 0.270** 0.079
(0.148) (0.065) (0.106) (0.053)
Dividend 0.010 − 0.001 − 0.003 − 0.010***
(0.009) (0.004) (0.007) (0.003)
Fin. Constraint 0.474*** 0.200*** 0.207*** 0.128***
(0.067) (0.033) (0.040) (0.024)
Investment − 0.027*** − 0.009** − 0.019*** − 0.010***
(0.009) (0.004) (0.007) (0.003)
R&D Intensity − 0.222* − 0.132*** − 0.072 − 0.121***
(0.126) (0.050) (0.071) (0.031)
Board Size 0.026 − 0.049 − 0.123 − 0.114
(0.321) (0.137) (0.227) (0.106)
Board Indep. 0.088*** 0.038*** 0.052*** 0.023***
(0.018) (0.008) (0.012) (0.006)
CEO Duality 0.005 0.011 − 0.019 0.000
(0.022) (0.010) (0.014) (0.007)
CEO Compensation 0.005 0.002 0.004 0.001
(0.006) (0.002) (0.003) (0.001)
CEO Tenure 0.009* 0.000 0.006 0.000
(0.006) (0.003) (0.004) (0.002)
CEO Age − 0.122 − 0.014 0.046 0.056
(0.275) (0.117) (0.197) (0.091)
Constant 0.029*** − 0.218 0.041*** 0.018 0.202*** 0.176 0.105*** 0.203**
(0.009) (0.271) (0.002) (0.116) (0.003) (0.183) (0.002) (0.088)
Firm effects Yes Yes Yes Yes Yes Yes Yes Yes
Year effects Yes Yes Yes Yes Yes Yes Yes Yes
N 17,004 15,256 17,002 15,256 17,029 15,256 17,007 15,256
r2 0.468 0.651 0.500 0.676 0.374 0.534 0.440 0.641
N_clust 1887 1693 1887 1693 1887 1693 1887 1693
This table provides the estimation results of the effect of Co-Option on measures of leverage. Standard errors robust to heteroscedasticity and clustering at firm level are
given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.
of all directors (Coles et al., 2014). Hence, that board/executive characteristics may drive co-option (Knippen
et al., 2018) as well as firm financing decisions (Chen, 2012; Fracassi,
∑
Boardsize
Tenurei,t × Co − opted Dummyi,t 2017) and thus cause a spurious association between financial leverage
Co − optionTW = i=1
and manager sentiment. A summary of all key variables used in our main
∑
Boardsize
Tenurei,t analyses and their descriptions is reported in Table 1.
i=1
4. Results and discussion

where Co − opted Dummyi, t is equal to one if the director i is co-opted by
year t, and zero otherwise. Tenurei, t denotes the tenure of the co-opted
4.1. Descriptive statistics and bivariate correlations
director i on the firm's board. This measure captures any increases in
power or influence of co-opted directors on board decisions over time, as
Table 2 presents the descriptive statistics of the variables for our
such directors work hand-in-hand with the CEO and other directors
empirical analysis. The independent variables, Co-opted Directors and
elected hitherto. Hence, the greater the tenure of co-opted directors, the
Tenure-weighted Co-option, have a mean value of 0.52 and 0.68
stronger their influence on board decisions. Higher values of both co-
respectively. These variables range between 0 and 1, with higher values
option measures indicate stronger board co-option.
signifying stronger co-option. In general, they exhibit a low degree of
variability, represented by a standard deviation of 0.32 and 0.33
3.3.3. Control variables
respectively. We also report the four measures of our dependent variable
In line with past empirical studies (Danso et al., 2019; Fosu, Danso,
(Leverage): (i) Net book leverage, (ii) Net market leverage, (iii) Book
Ahmad, & Coffie, 2016), we controlled for firm-level, board- and CEO-
leverage, (iv) Market leverage; the mean values of these are 0.06, 0.05,
specific variables that are likely to affect capital structure. These
0.21 and 0.11 respectively. Regarding our control variables, we observe
include firm size, Tobin's Q, return on assets, asset tangibility, earnings
that the mean value of Size is 7.45. This variable has a minimum and
volatility, financial constraints, investment, R&D intensity and a proxy
maximum value of 2.86 and 13.59 respectively, signifying a fair degree
for whether the firm pays common dividends. We also incorporate Board
of heterogeneity. The average value of ROA is 0.14, with a minimum and
and CEO controls such as board size, CEO Duality/Board Chair,
maximum value of − 1.69 and 1.18 respectively, suggesting that some of
Compensation, CEO Tenure, CEO age, and gender. The incorporation of
the sample firms had experienced a negative performance.
these board/executive controls addresses residual endogeneity concerns
6
T. Lartey et al.
Table 5
The influence of “non-co-opted and independent” vs. “co-opted but independent” directors on leverage.
NBLev NMLev BLev MLev NBLev NMLev BLev MLev
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
Non-Co-opted-Indep − 0.060*** − 0.067*** − 0.017*** − 0.024*** − 0.016*** − 0.033*** − 0.009*** − 0.018***

(0.017) (0.016) (0.004) (0.007) (0.006) (0.011) (0.003) (0.005)
Co-opted-Indep 0.068*** 0.060*** 0.019*** 0.018*** 0.012*** 0.026*** 0.009*** 0.015***
(0.020) (0.016) (0.004) (0.007) (0.006) (0.011) (0.003) (0.006)
Firm Size 0.044*** 0.020*** 0.031*** 0.016*** 0.045*** 0.021*** 0.031*** 0.016***
(0.004) (0.002) (0.002) (0.001) (0.004) (0.001) (0.002) (0.001)
Tobin's Q − 0.031*** − 0.004** − 0.002 − 0.011*** − 0.024*** − 0.001 − 0.002 − 0.010***
(0.006) (0.002) (0.004) (0.002) (0.005) (0.001) (0.003) (0.001)
ROA − 0.139* − 0.092*** − 0.262*** − 0.175*** − 0.211*** − 0.106*** − 0.273*** − 0.180***
(0.078) (0.028) (0.056) (0.025) (0.068) (0.024) (0.051) (0.022)
Tangibility 0.504*** 0.192*** 0.136*** 0.081*** 0.512*** 0.186*** 0.129*** 0.073***
(0.042) (0.018) (0.028) (0.015) (0.040) (0.017) (0.027) (0.014)
Earnings vol − 0.195 − 0.107 0.271** 0.078 − 0.399*** − 0.157*** 0.137* 0.044
(0.147) (0.065) (0.106) (0.054) (0.116) (0.048) (0.079) (0.036)
Dividend 0.010 − 0.001 − 0.003 − 0.010*** 0.010 − 0.001 − 0.004 − 0.010***
(0.009) (0.004) (0.007) (0.003) (0.009) (0.004) (0.006) (0.003)
Fin. Constraint 0.474*** 0.200*** 0.206*** 0.128*** 0.460*** 0.196*** 0.193*** 0.121***
(0.066) (0.032) (0.040) (0.023) (0.065) (0.031) (0.038) (0.023)
Investment − 0.027*** − 0.009** − 0.019*** − 0.010*** − 0.032*** − 0.010*** − 0.019*** − 0.010***
(0.009) (0.004) (0.007) (0.003) (0.009) (0.004) (0.007) (0.003)
R&D Intensity − 0.226* − 0.133*** − 0.074 − 0.122*** − 0.253** − 0.145*** − 0.062 − 0.126***
7
(0.125) (0.049) (0.071) (0.031) (0.118) (0.046) (0.067) (0.028)

Board Size 0.052 − 0.040 − 0.108 − 0.106 − 0.038 − 0.103 − 0.049 − 0.119
(0.320) (0.137) (0.227) (0.106) (0.306) (0.126) (0.206) (0.098)
Board Indep. 0.089*** 0.038*** 0.052*** 0.023*** 0.098*** 0.042*** 0.056*** 0.025***
(0.018) (0.008) (0.012) (0.006) (0.018) (0.008) (0.012) (0.006)
CEO Duality 0.005 0.011 − 0.020 − 0.000 0.007 0.011 − 0.022* − 0.001
(0.022) (0.010) (0.014) (0.007) (0.020) (0.009) (0.013) (0.006)
CEO Compensation 0.005 0.002 0.004 0.001 0.004 0.001 0.005 0.001
(0.006) (0.002) (0.003) (0.001) (0.005) (0.002) (0.003) (0.001)
CEO Tenure 0.010* 0.000 0.006 0.000 0.006 − 0.002 0.003 − 0.002
(0.006) (0.003) (0.004) (0.002) (0.005) (0.002) (0.004) (0.002)

CEO Age − 0.149 − 0.023 0.031 0.049 − 0.060 0.036 − 0.014 0.063
(0.275) (0.117) (0.197) (0.091) (0.261) (0.107) (0.177) (0.083)
Constant 0.080*** − 0.169 0.057*** 0.034 0.218*** 0.200 0.114*** 0.214** 0.006 − 0.212 0.036*** 0.043 0.203*** 0.109 0.103*** 0.192**
(0.007) (0.270) (0.002) (0.116) (0.002) (0.181) (0.001) (0.087) (0.016) (0.267) (0.003) (0.111) (0.005) (0.174) (0.003) (0.084)
Firm effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 17,003 15,255 17,001 15,255 17,028 15,255 17,006 15,255 17,003 15,772 17,001 15,772 17,028 15,772 17,006 15,772
r2 0.467 0.651 0.500 0.677 0.374 0.534 0.440 0.641 0.467 0.652 0.500 0.675 0.374 0.529 0.440 0.636
N_clust 1887 1693 1887 1693 1887 1693 1887 1693 1887 1750 1887 1750 1887 1750 1887 1750
This table provides the estimation results of the effect of “Non-Co-opted but independent” vs. “Co-Opted but independent” directors on leverage. Standard errors robust to heteroscedasticity and clustering at firm level are
given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.0.
Table 6
Co-option on leverage – partial adjustment model.
(1) (2) (3) (4) (5) (6) (7) (8)
Co-opted Directors 0.050*** 0.024*** 0.039*** 0.022***

(0.018) (0.009) (0.014) (0.007)
Co-OptionTW 0.049*** 0.015*** 0.031*** 0.012***
(0.018) (0.009) (0.012) (0.003)
Leveraget-1 0.794*** 0.796*** 0.290*** 0.291*** 0.274*** 0.275*** 0.112*** 0.113***
(0.024) (0.024) (0.012) (0.012) (0.025) (0.025) (0.011) (0.011)
Firm Size 0.138*** 0.138*** 0.076*** 0.076*** 0.110*** 0.109*** 0.051*** 0.050***
(0.034) (0.034) (0.014) (0.014) (0.029) (0.029) (0.011) (0.011)
Tobin's Q − 0.009 − 0.009 0.007*** 0.007*** 0.004 0.003 − 0.007*** − 0.007***
(0.007) (0.006) (0.003) (0.003) (0.007) (0.007) (0.002) (0.002)
ROA − 0.188** − 0.193** − 0.152*** − 0.155*** − 0.275*** − 0.272*** − 0.200*** − 0.199***
(0.085) (0.084) (0.036) (0.036) (0.067) (0.067) (0.030) (0.030)
Tangibility 0.122*** 0.125*** 0.058*** 0.059*** − 0.035 − 0.033 0.009 0.010
(0.026) (0.026) (0.015) (0.015) (0.024) (0.024) (0.014) (0.015)
Earnings vol − 0.082 − 0.082 − 0.138** − 0.148** 0.178* 0.211** 0.021 0.037
(0.116) (0.122) (0.062) (0.063) (0.097) (0.101) (0.048) (0.049)
Dividend 0.007 0.008 0.001 0.002 0.002 0.003 − 0.006** − 0.006*
(0.006) (0.006) (0.003) (0.003) (0.005) (0.005) (0.003) (0.003)
Investment − 0.004 − 0.004 − 0.000 − 0.000 − 0.015* − 0.014 − 0.006* − 0.006*
(0.005) (0.005) (0.002) (0.002) (0.009) (0.009) (0.003) (0.003)
R&D Intensity 0.139 0.134 0.003 0.001 0.030 0.025 − 0.069* − 0.072*
(0.093) (0.093) (0.036) (0.036) (0.066) (0.067) (0.038) (0.037)
Fin. Constraint 0.140*** 0.140*** 0.071*** 0.070*** 0.107*** 0.110*** 0.081*** 0.082***
(0.037) (0.037) (0.021) (0.022) (0.031) (0.031) (0.018) (0.019)
Board Size − 0.049 − 0.053 − 0.054 − 0.049 − 0.028 − 0.023 0.042 0.051
(0.269) (0.268) (0.156) (0.157) (0.281) (0.279) (0.138) (0.138)
Sizet-1 − 0.133*** − 0.132*** − 0.072*** − 0.072*** − 0.101*** − 0.101*** − 0.047*** − 0.046***
(0.035) (0.035) (0.014) (0.014) (0.030) (0.030) (0.011) (0.011)
TobinQt-1 0.001 0.002 − 0.000 0.000 0.008* 0.008* 0.002 0.002
(0.005) (0.005) (0.002) (0.002) (0.005) (0.005) (0.001) (0.001)
ROAt-1 0.118* 0.115* 0.038 0.036 0.130** 0.131** 0.043* 0.043*
(0.065) (0.065) (0.028) (0.028) (0.055) (0.055) (0.022) (0.023)
Fin. Constraintt-1 0.156*** 0.153*** 0.193*** 0.193*** 0.724*** 0.721*** 0.394*** 0.393***
(0.050) (0.049) (0.029) (0.029) (0.051) (0.050) (0.030) (0.030)
Co-opted Directorst-1 − 0.033* − 0.035** − 0.018** − 0.012 − 0.031** − 0.026* − 0.014** − 0.007
(0.017) (0.017) (0.008) (0.008) (0.014) (0.014) (0.007) (0.007)
CEO Duality 0.013 0.012 0.028*** 0.029*** − 0.010 − 0.011 0.019** 0.019**
(0.019) (0.019) (0.010) (0.011) (0.017) (0.017) (0.010) (0.010)
CEO Compensation − 0.003 − 0.003 − 0.002 − 0.002 0.000 0.000 − 0.001 − 0.001
(0.004) (0.004) (0.002) (0.002) (0.003) (0.003) (0.002) (0.002)
CEO Tenure − 0.043 − 0.043 − 0.038 − 0.036 0.040 0.043 0.003 0.006
(0.053) (0.053) (0.027) (0.027) (0.042) (0.042) (0.023) (0.023)
CEO Age 0.128 0.130 0.122 0.110 0.149 0.150 0.102 0.094
(0.214) (0.217) (0.175) (0.181) (0.350) (0.345) (0.210) (0.209)
Board Indep. 0.010 0.011 0.010 0.010 0.006 0.007 0.006 0.007
(0.011) (0.011) (0.006) (0.006) (0.010) (0.010) (0.006) (0.006)
Board Sizet-1 0.002 0.002 0.000 0.000 0.002 0.002 0.001 0.001
(0.002) (0.002) (0.001) (0.001) (0.002) (0.002) (0.001) (0.001)
CEO Aget-1 − 0.103 − 0.100 − 0.095 − 0.088 − 0.136 − 0.142 − 0.160 − 0.160
(0.175) (0.177) (0.147) (0.153) (0.282) (0.278)s (0.172) (0.172)
CEO Compensationt-1 0.004 0.004 0.003 0.004 − 0.000 − 0.000 0.001 0.001
(0.004) (0.004) (0.002) (0.002) (0.004) (0.004) (0.002) (0.002)
CEO Tenuret-1 0.041 0.041 0.031 0.028 − 0.023 − 0.026 0.002 − 0.001
(0.043) (0.043) (0.022) (0.022) (0.034) (0.034) (0.018) (0.018)
Constant − 0.023 − 0.025 0.038 0.037 0.043 0.035 0.051 0.046
(0.205) (0.205) (0.113) (0.114) (0.198) (0.197) (0.100) (0.100)
N 13,832 13,832 13,832 13,832 13,832 13,832 13,832 13,832
r2 0.905 0.905 0.882 0.881 0.801 0.801 0.836 0.835
N_clust 1655 1655 1655 1655 1655 1655 1655 1655
The table reports the estimates based on the partial adjustment model of leverage defined in Eq. (4). Standard errors robust to heteroscedasticity and clustering at
industry level are given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.01.
In Table 3, we report the correlation between key variables in our Regarding the control variables, the correlations among them appear
model. We observe that the correlations between board co-option (Co- low, indicating that multicollinearity is not an issue in this study. In
opted Directors and Co-optionTW) are high, indicating that both inde general, the findings from both descriptive summary and the correlation
pendent measures may capture a similar construct (Board co-option). matrix suggest that none of the variables suffer from any momentous
Similarly, the correlation coefficients between our four leverage mea biases (e.g., limited variation and heterogeneity or large outliers) that
sures (NBLev, NMLev, BLev and MLev) are high, indicating that these may plague our regression results.
dependent variables also capture similar information (Leverage).
8
Table 7
Robustness check: tenure-weighted board co-option and leverage.
(1) (2) (3) (4) (5) (9) (10) (12)
Co-OptionTW 0.064*** 0.053*** 0.020*** 0.016*** 0.020*** 0.027*** 0.012*** 0.012***

(0.015) (0.012) (0.003) (0.005) (0.004) (0.008) (0.003) (0.004)
Firm Size 0.045*** 0.020*** 0.031*** 0.016***
(0.004) (0.001) (0.002) (0.001)
Tobin's Q − 0.024*** − 0.001 − 0.002 − 0.009***
(0.005) (0.001) (0.003) (0.001)
ROA − 0.211*** − 0.106*** − 0.274*** − 0.180***
(0.068) (0.024) (0.051) (0.022)
Tangibility 0.517*** 0.188*** 0.131*** 0.074***
(0.040) (0.017) (0.027) (0.014)
Earnings vol − 0.404*** − 0.158*** 0.135* 0.043
(0.117) (0.048) (0.079) (0.036)
Dividend 0.011 − 0.001 − 0.004 − 0.010***
(0.009) (0.004) (0.006) (0.003)
Fin. Constraint 0.460*** 0.196*** 0.193*** 0.122***
(0.065) (0.032) (0.038) (0.023)
Investment − 0.032*** − 0.010*** − 0.019*** − 0.010***
(0.009) (0.004) (0.007) (0.003)
R&D Intensity − 0.246** − 0.143*** − 0.059 − 0.124***
(0.119) (0.046) (0.068) (0.028)
Board Size − 0.056 − 0.108 − 0.059 − 0.123
(0.307) (0.126) (0.207) (0.098)
Board Indep. 0.098*** 0.042*** 0.056*** 0.025***
(0.018) (0.008) (0.012) (0.006)
CEO Duality 0.006 0.011 − 0.023* − 0.001
(0.020) (0.009) (0.013) (0.006)
CEO Compensation 0.003 0.001 0.004 0.001
(0.005) (0.002) (0.003) (0.001)
CEO Tenure 0.007 − 0.001 0.004 − 0.001
(0.005) (0.002) (0.004) (0.002)
CEO Age − 0.037 0.042 − 0.002 0.069
(0.261) (0.107) (0.178) (0.084)
_cons 0.015 − 0.214 0.037*** 0.043 0.198*** 0.102 0.102*** 0.194**
(0.012) (0.267) (0.002) (0.111) (0.003) (0.174) (0.002) (0.084)
N 17,004 15,773 17,002 15,773 17,029 15,773 17,007 15,773
r2 0.469 0.652 0.501 0.675 0.375 0.530 0.441 0.636
N_clust 1887 1750 1887 1750 1887 1748 1887 1750
This table provides the estimation results of the effect of Co-Option weighted by tenure on measures of leverage. Standard errors robust to heteroscedasticity and
clustering at firm level are given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.01.
4.2. Board co-option and leverage The greater economic effect of board co-option on net leverage
relative to that of total leverage suggests that board co-option does affect
Table 4 shows the empirical results of the impact of board co-option a firm's cash holdings. While the net leverage results are primarily
on the four measures of leverage. Models 1 and 2 (3 and 4) report the driven by changes in debt financing, the results for total leverage
results for net book leverage (net market leverage). The use of debt net incorporate the effect of cash holdings, thus suggesting that cash and
of cash holdings accounts for the financial flexibility. The other models debt play important roles in influencing competitive outcomes (Fresard,
(5 and 6; 7 and 8) under book leverage and market leverage serve as 2010; O'Brien, 2003). Furthermore, the presence of agency problems or
robustness checks on the earlier models. All models incorporate firm the anticipation of future cash flows may also underline the differences
fixed and year fixed effects. Under each leverage measure, the second in economic effect (Gamba & Triantis, 2008; Lartey, Kesse, & Danso,
model incorporates conventional capital structure, board, and CEO 2020). When board monitoring is weaker, the influx of free cash flow
control variables. intensifies agency conflicts and gives the CEO more room for discretion
Models 1–4 of the table document that board co-option has a positive (Acharya, Almeida, & Campello, 2007). Therefore, while Chintrakarn
and statistically significant impact on the net leverage at the 1% level. et al. (2016) contend that board co-option leads to significantly higher
The estimated coefficients suggest that, economically, a rise in board co- R&D investments, Jiraporn and Lee (2018) suggest that co-opted di
option induces an increase in firm's ratio of total debt (net of cash rectors have a weaker propensity towards paying dividends and, even
holdings) per dollar of book (market) assets by 5.6 (1.9) cents, which where firms paid dividends prior to their appointment, their presence
represents a 19.31% (13.57%) increase relative to the sample standard significantly lowers dividend pay-outs.
deviation for net book (market) leverage of 0.29 (0.14). Hypothesis 1 is
therefore supported. The results under the two other standard leverage 4.3. Co-opted independent directors versus non-co-opted independent
measures (book leverage and market leverage) in models 5–8 provide directors and capital structure
strong support regarding the effects of the board co-option on capital
structure choice. The results suggest that an increase in board co-option To test Hypothesis 2, we examine whether independent directors
is accompanied by weak monitoring and poor advice, thereby leading who are co-opted by the CEO are different in monitoring effectiveness of
firms to lever up by taking on more debt. Economically, the results show financial leverage relative to other independent directors who are not
a 16.11% (12.73%) increase relative to the sample standard deviation of co-opted. Prior evidence suggests that independent directors, with no
0.18 (0.11). ties to the firm other than their directorship, are highly effective in
9
Table 8
Robustness check: board co-option and new debt issues.
(1) (2) (3) (4) (5) (6) (7) (8)
Co-opted Directors 0.054*** 0.020*** 0.029*** 0.017***

(0.014) (0.006) (0.009) (0.005)
Co-OptionTW 0.054*** 0.017*** 0.028*** 0.014***
(0.013) (0.006) (0.009) (0.004)
Firm Size 0.041*** 0.040*** 0.019*** 0.019*** 0.027*** 0.027*** 0.013*** 0.013***
(0.004) (0.004) (0.001) (0.001) (0.002) (0.002) (0.001) (0.001)
Tobin's Q − 0.032*** − 0.031*** − 0.008*** − 0.007*** − 0.006* − 0.006* − 0.011*** − 0.011***
(0.005) (0.005) (0.002) (0.002) (0.003) (0.003) (0.002) (0.002)
ROA − 0.068 − 0.090 − 0.027 − 0.033 − 0.172*** − 0.170*** − 0.118*** − 0.120***
(0.073) (0.074) (0.025) (0.025) (0.059) (0.060) (0.021) (0.022)
Tangibility 0.461*** 0.461*** 0.165*** 0.165*** 0.109*** 0.112*** 0.069*** 0.070***
(0.042) (0.042) (0.018) (0.018) (0.029) (0.028) (0.016) (0.016)
Earnings vol − 0.197 − 0.327** − 0.090 − 0.117** 0.211** 0.230** 0.015 0.009
(0.150) (0.148) (0.060) (0.057) (0.102) (0.103) (0.047) (0.044)
Dividend 0.010 0.010 − 0.002 − 0.002 − 0.005 − 0.004 − 0.010*** − 0.010***
(0.010) (0.010) (0.004) (0.004) (0.007) (0.007) (0.003) (0.003)
Fin. Constraint 0.339*** 0.333*** 0.136*** 0.135*** 0.168*** 0.171*** 0.103*** 0.103***
(0.067) (0.067) (0.032) (0.033) (0.038) (0.038) (0.022) (0.022)
Investment − 0.025*** − 0.026*** − 0.006** − 0.006** − 0.011** − 0.010** − 0.007** − 0.007**
(0.009) (0.009) (0.003) (0.003) (0.005) (0.005) (0.003) (0.003)
R&D Intensity − 0.383*** − 0.373*** − 0.142*** − 0.142*** − 0.065 − 0.066 − 0.095*** − 0.095***
(0.126) (0.125) (0.046) (0.045) (0.074) (0.073) (0.029) (0.029)
Board Size 0.275 0.264 0.088 0.086 0.018 0.007 − 0.061 − 0.064
(0.332) (0.331) (0.135) (0.134) (0.218) (0.218) (0.103) (0.103)
Board Indep. 0.084*** 0.084*** 0.038*** 0.038*** 0.053*** 0.053*** 0.024*** 0.024***
(0.020) (0.020) (0.008) (0.008) (0.012) (0.012) (0.006) (0.006)
CEO Duality 0.014 0.014 0.010 0.010 − 0.017 − 0.017 − 0.000 − 0.000
(0.023) (0.023) (0.010) (0.010) (0.013) (0.013) (0.007) (0.007)
Compensation 0.008 0.008 0.002 0.002 0.006** 0.006** 0.002* 0.002*
(0.006) (0.006) (0.002) (0.002) (0.003) (0.003) (0.001) (0.001)
CEO Tenure 0.001 0.001 − 0.003 − 0.003 0.001 0.001 − 0.003 − 0.003
(0.006) (0.006) (0.003) (0.003) (0.004) (0.004) (0.002) (0.002)
CEO Age − 0.318 − 0.306 − 0.125 − 0.124 − 0.069 − 0.059 0.015 0.018
(0.287) (0.286) (0.116) (0.115) (0.191) (0.191) (0.089) (0.089)
Constant − 0.434 − 0.422 − 0.087 − 0.079 0.067 0.067 0.152* 0.157*
(0.277) (0.276) (0.114) (0.114) (0.171) (0.171) (0.084) (0.084)
N 14,149 9148 14,148 9147 14,149 9148 14,148 9147
r2 0.651 0.652 0.684 0.684 0.533 0.533 0.642 0.642
N_clust 1692 1094 1692 1094 1692 1094 1692 1094
The table reports the estimates of the effects of board co-option on new debt issues. Standard errors robust to heteroscedasticity and clustering at firm level are given in
parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.01.
performing their oversight role of monitoring corporate policies to suggest that co-option weakens the effective monitoring, thereby
improve firm outcomes (e.g., Balsmeier et al., 2017; Lu & Wang, 2018). exerting a positive influence on the firm's leverage ratio. This may be the
Lim et al. (2020) note that director co-option and independence as case because co-opted directors are less likely to remove or punish CEOs
important board characteristics are not mutually exclusive and may (Chintrakarn et al., 2016; Coles et al., 2014), and may encourage more
overlap with each other. For instance, a group of the directors that have risk-taking with high potential payoffs, thereby increasing the firms'
been captured in the measure of co-option may actually be independent, financial leverage. In contrast, the results (as reported in Table 5) show
and the converse may be true. To test the monitoring effectiveness of that “Non-Co-opted Independent” directors reduce financial leverage,
independent and co-opted directors, we follow Coles et al.'s (2014) with the effect being statistically and economically significant. The re
classification and categorise directors into two components, namely, co- sults may be explained by the argument that, when directors are not co-
opted independent directors and non-co-opted independent directors. opted and possess a degree of permanence and independence, they have
The distinction between co-opted directors who are independent from greater incentives and ability to provide the required monitoring and
directors and those who are not co-opted but independent is important advisory services to management without fear of retribution. Such
to obtain further insights into the effects of the monitoring role of co- findings appear consistent with the argument by Lu and Wang (2018)
opted boards vis-a-vis independent directors on capital structure de which suggests that firms with more independent boards tend to use
cisions. Consequently, we measure “Co-opted Independent” as a per more equity-based rather than debt-based compensation, especially
centage of independent directors on the board that have been elected stock options, to promote managerial risk-taking. More importantly,
after the incumbent CEO assumed office and “Non-Co-opted Indepen Non-Co-opted Independent directors may serve as a more precise mea
dent” as a percentage of independent directors already serving on the sure of the quality and effectiveness of internal monitoring relative to
board at the time the CEO assumed office. the conventional measure of board independence. Taken together, the
The results reported in Table 5 show that co-opted independent di findings suggest that independent directors who are not co-opted are
rectors (“Co-opted Independent”) are associated with higher financial effective monitors and reduce a firm's financial leverage, whereas co-
leverage, which is both statistically and economically significant. The opted independent directors are not and tend to increase the financial
results that co-opted independent directors (though independent of the leverage of a firm. The results therefore provide strong support for Hy
CEO in the traditional and legal sense) increase financial leverage pothesis 2, indicating that not all independent directors are effective
10
T. Lartey et al.
Table 9
Addressing endogeneity using two-step GMM: co-option and leverage.
(1) (2) (9) (10) (3) (4) (11) (12) (5) (6) (13) (14) (7) (8) (15) (16)
Co-opted Directors 0.122*** 0.110*** 0.173*** 0.154*** 0.144*** 0.118*** 0.084*** 0.050***
(0.044) (0.035) (0.019) (0.032) (0.017) (0.026) (0.010) (0.012)
Co-OptionTW 0.167*** 0.127*** 0.151*** 0.160*** 0.126*** 0.122*** 0.074*** 0.051***
(0.040) (0.034) (0.018) (0.041) (0.015) (0.033) (0.009) (0.014)
Firm Size − 0.010 − 0.034 − 0.001 − 0.009 0.014** 0.007 0.008*** 0.005
(0.019) (0.024) (0.007) (0.009) (0.006) (0.007) (0.003) (0.003)
Tobin's Q 0.054** 0.090** 0.025*** 0.039*** 0.024*** 0.034*** − 0.004 0.001
(0.022) (0.035) (0.009) (0.014) (0.007) (0.011) (0.003) (0.005)
ROA − 1.060*** − 1.523*** − 0.477*** − 0.653*** − 0.529*** − 0.661*** − 0.307*** − 0.364***
(0.288) (0.403) (0.116) (0.161) (0.093) (0.123) (0.043) (0.058)
Tangibility 0.700*** 0.813*** 0.311*** 0.353*** 0.276*** 0.309*** 0.163*** 0.176***
(0.123) (0.150) (0.048) (0.058) (0.040) (0.047) (0.019) (0.022)
Earnings vol − 2.102*** − 1.661*** − 0.866*** − 0.718*** − 0.353* − 0.221 − 0.199** − 0.152*
(0.633) (0.636) (0.252) (0.250) (0.208) (0.205) (0.097) (0.091)
Dividend − 0.180*** − 0.230*** − 0.075*** − 0.094*** − 0.053** − 0.067** − 0.033*** − 0.039***
(0.064) (0.088) (0.025) (0.034) (0.021) (0.028) (0.009) (0.012)
Investment − 0.082*** − 0.081*** − 0.028*** − 0.029*** − 0.036*** − 0.035*** − 0.015*** − 0.015***
(0.022) (0.024) (0.008) (0.009) (0.008) (0.008) (0.003) (0.004)
R&D Intensity − 0.152 − 0.523 − 0.180 − 0.319** − 0.071 − 0.179 − 0.166*** − 0.212***
(0.344) (0.380) (0.136) (0.149) (0.103) (0.113) (0.049) (0.052)
Fin. Constraint 0.187 0.167 0.083 0.074 0.072 0.068 0.054* 0.052
(0.231) (0.255) (0.089) (0.099) (0.071) (0.079) (0.032) (0.036)
11
Board Size 1.209*** 1.272*** 0.528*** 0.554*** 0.404*** 0.415*** 0.223*** 0.229***
(0.371) (0.427) (0.141) (0.164) (0.114) (0.131) (0.050) (0.057)
Board Indep. 0.162 0.207* 0.077** 0.094** 0.077** 0.090*** 0.043*** 0.049***
(0.099) (0.108) (0.038) (0.042) (0.032) (0.035) (0.014) (0.015)
CEO Duality − 0.254** − 0.325** − 0.087** − 0.113** − 0.084** − 0.104*** − 0.027* − 0.036**
(0.108) (0.127) (0.041) (0.048) (0.033) (0.038) (0.014) (0.016)
CEO Compensation 0.019 0.008 0.007 0.003 0.011 0.008 0.004 0.003
(0.023) (0.023) (0.009) (0.009) (0.007) (0.007) (0.003) (0.003)
CEO Tenure 0.448*** 0.470*** 0.166*** 0.174*** 0.128*** 0.134*** 0.052*** 0.054***
(0.104) (0.129) (0.040) (0.050) (0.032) (0.039) (0.014) (0.017)
CEO Age 0.358 0.607* 0.075 0.166 0.056 0.133 − 0.020 0.011

(0.256) (0.315) (0.099) (0.122) (0.086) (0.103) (0.039) (0.046)
Constant − 0.212*** − 0.936*** − 0.242*** − 1.109*** − 0.085*** − 0.360*** − 0.097*** − 0.425*** − 0.053*** − 0.274*** − 0.064*** − 0.324*** − 0.033*** − 0.117*** − 0.039*** − 0.138***
(0.023) (0.200) (0.027) (0.286) (0.010) (0.077) (0.012) (0.111) (0.008) (0.062) (0.010) (0.088) (0.005) (0.027) (0.006) (0.038)
Firm Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 16,518 14,718 17,518 14,717 16,517 14,718 17,517 14,717 16,518 14,718 17,518 14,717 16,517 14,718 17,517 14,717
N_clust 1376 950 1411 1272 1376 950 1411 1272 1376 950 1411 1272 1376 950 1411 1272
K-P WF statistic 46.006 13.169 43.280 19.429 45.930 13.169 43.196 19.429 46.006 13.169 43.280 19.429 45.930 13.169 43.196 19.429
K-P LM statistic 72.134 24.067 68.371 17.511 71.988 24.067 68.209 17.511 72.134 24.067 68.371 17.511 71.988 24.067 68.209 17.511
Hansen J statistic 1.811 2.265 1.322 1.590 1.316 1.972 0.850 1.378 2.848 1.354 9.803 0.908 1.955 0.671 1.462 0.406
Hansen J p-value 0.178 0.132 0.250 0.207 0.251 0.160 0.357 0.240 0.102 0.244 0.102 0.341 0.162 0.413 0.227 0.524
This table presents the two-stage GMM estimation results of the effects of co-option on leverage. Standard error robust to heteroscedasticity and clustering at firm level are given in parentheses. Significance indicators: * p
< 0.10, ** p < 0.05, *** p < 0.01.
monitors and may influence corporate financial decisions differently. adjusting the debt ratio, and that firms' leverage levels are persistent
over time (Ozkan, 2001). Where the cost associated with disequilibrium
4.4. Board co-option and the speed of adjustment exceeds the adjustment cost, the estimated adjustment coefficient
should be close to zero (Gaud, Jani, Hoesli, & Bender, 2005). Moreover,
In Table 6, we present results of the extent and speed of adjustment the swift adjustment towards the firm's capital ratio suggests that capital
by firms with co-opted boards towards the optimal capital structure. As structure decisions are not driven by the pecking order or market timing
discussed earlier, we expect firms with highly co-opted boards to have a theories when the firm's directors are co-opted (Flannery & Rangan,
higher cost of equity, hence co-opted firms may employ a lower degree 2006; Lartey et al., 2020).
of equity financing and may have a higher target leverage. We find firms
with co-opted boards adjust faster to their target leverage ratios. This is 4.5. Robustness test
particularly important given that past evidence suggests that market
timing considerations may drive a firm's issuance of securities (see Alti, 4.5.1. Tenure-weighted board co-option and leverage (over time)
2006; Hovakimian, 2004, 2006, 2011). Our results reveal that the co To further strengthen the results documented in Table 4, we
efficient of target leverage is positive and significant at the 1% level. The employed tenure-weighted board co-option to account for the likelihood
coefficient of the lagged leverage variables is positive and significant that directors elected by the incumbent CEO become significantly co-
across all model specifications. The speed of adjustment parameter, λ, is opted through time and that their influence surges with their tenure
measured based on Eq. (7) as one minus the estimated coefficient of the on the board. Thus, it may be argued that co-option surges with CEO
lagged leverage variable. Under the conventional co-option models (1, tenure and that our findings on co-option merely capture the effect of
3, 6 and 8), the average speed of adjustment ranges between 0.206 and CEO tenure (Coles et al., 2014). Consequently, we employed an alter
0.710 (total debt net of cash holdings – book and market) and 0.726 and native measure of board co-option measured as the sum of the tenure of
0.888 (book leverage and market leverage). This indicates that, upon co- co-opted directors divided by the total tenure of all directors (Coles
option of a firm's board, the firm closes, on average, between 21 and et al., 2014). This measure captures any increases in power or influence
71% (debt net of cash holdings) and 73–89% (book and market of co-opted directors on board decisions over time, as such directors
leverage) of the gap between current and desired leverage per year. The work in tandem with the CEO and other directors elected hitherto. The
adjustment coefficient is high and provides a justification that the dy results presented in Table 7 suggest that, the greater the tenure of co-
namics implied by our model are not rejected and that the firms adjust opted directors, the stronger their influence on board decisions.
relatively quickly towards their target leverage ratios through board co- Higher values of both co-option measures indicate stronger board co-
option. The high implied adjustment speed suggests that the typical firm option. The positive effect on leverage reinforces our main results that
removes more than half of the effect of a shock on its book and market firms with a higher proportion of co-opted directors have greater
leverage within a year upon board co-option. leverage due to weaker internal monitoring, and such results appear
In models 2, 4, 6 and 8, we capture the influence of co-option that persistence over time.
occurs through time and tenure on the board. We find consistent results
which show that the average speed of adjustment ranges between 0.203 4.5.2. Does board co-option drive new debt issues?
and 0.709 (total debt net of cash holdings – book and market); and 0.725 To confirm whether board co-option drives new debt issues and
and 0.887 (book leverage and market leverage). A probable explanation consequently increases overall firm financial leverage, we test the
behind the high adjustment speed is that the cost associated with any relationship between board co-option and new debt issues. Kochhar and
deviations from the target leverage level outweighs the relative cost of Hitt (1998) contend that, when board co-option is high, firms increase
Table 10
Co-option and tax/debt benefits/implications.
Net book leverage Net market leverage
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Co-opted Directors 0.061*** 0.061*** 0.061*** 0.057*** 0.087*** 0.021*** 0.014 0.019*** 0.018*** 0.029***
(0.015) (0.023) (0.017) (0.014) (0.026) (0.007) (0.010) (0.007) (0.006) (0.011)
Marginal Tax Rate − 0.253* − 0.152 − 0.174 − 0.106**
(0.151) (0.115) (0.108) (0.079)
Co-opted × Marginal Tax Rate − 0.247 − 0.467** − 0.208 − 0.381
(0.240) (0.232) (0.169) (0.156)
Depreciation 0.705* 1.020** 0.222*** 0.362*
(0.383) (0.472) (0.165) (0.209)
Co-opted × Depreciation − 0.182 − 0.638 0.066 − 0.136
(0.489) (0.523) (0.216) (0.239)
Tax Loss Carry Forward 0.074*** 0.033* 0.027*** 0.012*
(0.016) (0.022) (0.009) (0.011)
Co-opted × Tax Loss Carry Forward − 0.114 − 0.078 − 0.045 − 0.034
(0.034) (0.042) (0.016) (0.020)
Investment Tax Credit − 0.115 − 0.302* − 0.117 − 0.211**
(0.327) (0.226) (0.149) (0.089)
Co-opted × Investment Tax Credit 1.096 1.898 0.781 1.224
(1.633) (1.124) (0.745) (0.446)
Constant 0.033*** 0.004 0.023** 0.028*** − 0.006 0.045*** 0.034*** 0.039*** 0.041*** 0.029***
(0.010) (0.016) (0.011) (0.009) (0.020) (0.004) (0.007) (0.005) (0.004) (0.008)
Firm Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 17,002 16,972 11,997 16,958 11,964 17,002 16,972 11,997 16,956 11,964
r2 0.469 0.474 0.502 0.470 0.510 0.505 0.505 0.535 0.501 0.545
N_clust 1887 1883 1643 1886 1639 1887 1883 1643 1886 1639
This table presents the estimation results of the recognition of tax benefits on co-option-leverage nexus. Standard errors robust to heteroscedasticity and clustering at
firm level are given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.01.
12
Table 11
Co-option and leverage: does financial crisis matter?
NBLev NMLev NBLev NMLev NBLev NMLev
(1) (2) (3) (4) (5) (6)
Co-opted Directors 0.080*** 0.018*** 0.066*** 0.022*** 0.053*** 0.013***

(0.025) (0.002) (0.029) (0.001) (0.021) (0.001)
Pre-crisis − 0.201*** − 0.053***
(0.034) (0.012)
Co-option × Pre-crisis 0.139*** 0.021***
(0.049) (0.002)
Crisis 0.089*** 0.034***
(0.022) (0.010)
Co-option × Crisis − 0.031 − 0.009
(0.034) (0.015)
Post-crisis − 0.245*** − 0.078***
(0.029) (0.012)
Co-option × Post-crisis 0.076 0.014
(0.060) (0.026)
Firm Size 0.035*** 0.019*** 0.044*** 0.020*** 0.039*** 0.018***
(0.006) (0.002) (0.008) (0.003) (0.007) (0.003)
Tobin's Q − 0.024*** − 0.001 − 0.021*** − 0.000 − 0.020*** − 0.000
(0.006) (0.001) (0.006) (0.002) (0.006) (0.002)
ROA − 0.283*** − 0.113*** − 0.205* − 0.104*** − 0.213** − 0.106***
(0.105) (0.030) (0.105) (0.037) (0.102) (0.036)
Tangibility 0.401*** 0.171*** 0.507*** 0.184*** 0.447*** 0.165***
(0.051) (0.025) (0.070) (0.031) (0.067) (0.031)
Earnings vol − 0.548*** − 0.222*** − 0.395** − 0.154** − 0.315* − 0.127**
(0.145) (0.057) (0.178) (0.067) (0.164) (0.064)
Dividend 0.048*** − 0.002 0.011 − 0.001 0.008 − 0.002
(0.015) (0.006) (0.016) (0.007) (0.016) (0.007)
Fin. Constraint 0.236*** 0.189*** 0.472*** 0.201*** 0.531*** 0.221***
(0.071) (0.032) (0.097) (0.044) (0.103) (0.048)
Investment − 0.011 − 0.009** − 0.030** − 0.009* − 0.030** − 0.010*
(0.007) (0.004) (0.014) (0.005) (0.015) (0.005)
R&D Intensity − 0.898*** − 0.145** − 0.234 − 0.139** − 0.322* − 0.169**
(0.187) (0.057) (0.173) (0.068) (0.172) (0.068)
Board Size − 0.441 0.134*** − 0.130 − 0.139 − 0.107 − 0.123
(0.417) (0.035) (0.449) (0.191) (0.433) (0.188)
Board Indep 0.084** 0.041*** 0.092** 0.039*** 0.078** 0.035**
(0.033) (0.012) (0.037) (0.015) (0.034) (0.014)
CEO Duality − 0.009 0.013 0.003 0.010 − 0.002 0.008
(0.033) (0.012) (0.036) (0.016) (0.033) (0.015)
CEO Compensation 0.005 − 0.000 0.002 0.000 − 0.003 − 0.001
(0.007) (0.002) (0.010) (0.003) (0.008) (0.003)
CEO Tenure 0.000 − 0.003 0.008 − 0.001 0.008 − 0.001
(0.008) (0.003) (0.009) (0.004) (0.009) (0.004)
CEO Age 0.383 − 0.148*** 0.022 0.067 0.009 0.056
(0.358) (0.031) (0.382) (0.162) (0.370) (0.160)
_cons 0.086 − 0.127 − 0.158 0.063 − 0.027 0.101
(0.394) (0.094) (0.435) (0.184) (0.413) (0.178)
Firm effect Yes Yes Yes Yes Yes Yes
N 15,774 15,774 15,774 15,774 15,774 15,774
r2 0.412 0.565 0.662 0.683 0.683 0.692
N_clust 1750 1750 1750 1750 1750 1750
This table presents the estimation results of the recognition of the crisis effect on the co-option-leverage nexus. Standard errors robust to heteroscedasticity and
clustering at firm level are given in parentheses. Significance indicators: * p < 0.10, ** p < 0.05, *** p < 0.01.
their borrowing, which may particularly increase the strategic benefit of 4.6. Addressing potential endogeneity
unused debt capacity. To measure a firm's new debt issue, we first
deduct the value of the firm's leverage value for the previous year (t-1) It may be argued that board co-option may be correlated with a
from the current year (t) leverage value. Further, we use the dummy variable that has been omitted from the analysis but that may partly
variable, an indicator equal to one if the difference between the two determine leverage. For instance, firm performance or CEO power may
values [t-(t-1)] is positive, and zero otherwise, to proxy for the presence drive both board co-option (Knippen et al., 2018) and the levels of
of new debt issues. The results reported in Table 8 remain positive and financial leverage. Likewise, a firm with unused debt capacity may
statistically significant at the 1% level, indicating that board co-option perceive board monitoring to be too rigorous, leading to its inability to
drives new debt issues and consequently the overall firm leverage. access and utilise additional external funding. In other words, board co-
Overall, the results indicate that, where the power or influence of co- option may not be the driver of leverage, but firms with excess debt
opted directors on board and firm decisions increases over time, the capacity may be willing to accumulate further leverage. Also, where a
impact of board co-option on financial leverage is manifested through CEO's past performance is driven by aggressive borrowing and high
new debt issues. leverage, they may be inclined to favour board members that support
their corporate objectives. Lastly, a measurement error in our co-option
variable may influence the co-option-leverage nexus. The mismeasure
ment of a measure in an empirical model leads to inconsistent regression
13
coefficients. If this is the case, the resulting coefficients may be biased carry forwards/assets, and investment tax credits/assets). Table 10 re
due to endogeneity through omitted variables (unobserved heteroge ports the estimated models with control variables not reported for
neity), simultaneity (reverse causality), or measurement errors. In this brevity. The coefficients on all interaction variables are statistically
section, we take extra steps to address any potential endogeneity issues insignificant, indicating that the co-option effect on leverage is not due
and show that our findings remain robust. to tax benefits. Nevertheless, the significant impact of board co-option
We re-estimate our main models using a 2-step instrumental variable on financial leverage remains unchanged.
Generalised Method of Moments (GMM) approach (Blundell & Bond,
1998). To choose the instrument, we followed prior literature on the 4.7.2. Financial crisis as a potential channel for high leverage
empirical determinants of board control and monitoring. Following In this section, we use the 2007/08 financial crisis as an exogenous
Jiraporn and Lee (2018), we created a new co-option variable, co-option shock that may affect leverage to address potential endogeneity issues.
in the earliest year, by identifying the earliest year each firm entered the In the wake of the financial crisis, evidence suggests that firms that were
study sample and replacing each fiscal year's co-option value by the managed by overconfident executives accumulated greater leverage,
earliest year's value co-option. We contend that board co-option in the and this consequently made these firms more susceptible to shocks
earliest year may not be driven by leverage choices in any of the suc during the crisis (see e.g., Ho, Huang, Lin, & Yen, 2016). Nonetheless,
cessive years, thus mitigating any chances of reverse causality. This new theory posits that CEOs are allowed to exercise their discretion to alter
variable, co-option in the earliest year, is then utilised as the instru their firm risk by diversifying their activities and choosing investment
mental variable (IV) to estimate the GMM regression. We regress the projects or assets that will mitigate cash flow or earnings volatility
board co-option measure on the firm-, executive- and board-level vari (Chaivisuttangkun & Jiraporn, 2021). The presence of idiosyncratic risk
ables, and include the predicted variables in the second stage. The re ensures that CEOs develop strong risk aversion during difficult times
sults are presented in Table 9. The coefficients for board co-option and (Gormley & Matsa, 2016; Panousi & Papanikolaou, 2012). This risk-
the four variations of financial leverage are positive and significant at averse nature of CEOs may lead to underinvestment when firm vulner
the 1% level across all the models. This suggests that the instruments are ability or uncertainty is high (Danso et al., 2019). Consistent with this
relevant, and the diagnostic tests also confirm the relevance and validity argument, this section builds on our baseline model to empirically test
of the instruments.2 The results corroborate our main findings in whether financial vulnerability as manifested during the 2007/08
Table 4, suggesting that a higher degree of board co-option increases financial crisis has any implications for the impact of board co-option on
financial leverage as board co-option weakens effective monitoring of leverage. We augmented our baseline specification to include in
executive management. teractions between the co-option measure and variables for pre-crisis,
crisis and post-crisis periods. The results are reported in Table 11. We
4.7. Further tests find that the estimated impact of board cop-option on financial leverage
remains unchanged. However, the direction/relationship and statistical
4.7.1. Tax gains/benefits as a potential channel for high leverage significance of the interaction variables appear dissimilar. The coeffi
cient of the pre-crisis interaction is positive and statistically significant.
The evidence presented above indicates that board co-option leads a
firm to increase in leverage ratio. However, a potential mechanism This suggests that CEOs exhibited their excessive risk appetite during the
pre-crisis era where firms were able to accumulate greater leverage
through which board co-option could result in the increase of firm
leverage is grounded in the trade-off theory of capital structure, which under less stringent rules and requirements. Under the crisis model
(3–4), the coefficient of the crisis interaction is negative but statistically
posits that the rational firm will choose its optimal level of leverage by
significant, thus suggesting that executive risk aversion is particularly
balancing the costs (e.g., bankruptcy costs) against the gains (e.g., tax
more pronounced during periods of financial vulnerability. Given that
gains/shield or reduction in agency costs) associated with debt accu
co-opted directors allow a CEO to adopt corporate policies that reflect
mulation (Lartey et al., 2020; Lemmon & Zender, 2010). Under the static
the CEO's own risk aversion, strong risk aversion may decrease firm
trade-off theory, it is argued that firm financing policies are very
distress or risk through leverage reductions during the crisis period.
importance since they affect the resources under a CEO's control (Mor
Moreover, it may be argued that, during a crisis period, it is desirable to
ellec, 2004; Stulz, 1990). However, the dynamic trade-off theory may
decrease firm risk. Therefore, in light of the shocks to credit markets,
incentivise firms to opt for new debt financing rather than issuing equity
firms responded by cutting capital expenditures, reducing debt issuance,
when the benefits of increased debt exceed the adjustment/transactions
and relying on internal liquidity to achieve investment objectives (see
costs (Hovakimian & Li, 2011). As a result, firms that have unused debt
Lartey et al., 2020). Under the post-crisis interaction, we find a positive
capacity will aggressively re-balance their capital structure by accu
but insignificant relationship. Plausible explanations for this finding can
mulating more debt towards maximising the benefits of tax deductions
be attributed to the process of learning, adaptation and change that
on debt. In addition, the agency theory also suggests that, by accumu
underlines lending/borrowing decisions and drives path-dependency.
lating debt, firms can benefit from external discipline mechanisms,
Therefore, there was a more strengthened co-option-leverage nexus
which helps to mitigate the agency problems associated with free cash
post-crisis as lenders began considering their pre-crisis misconceptions
flows. Against this backdrop, the incentives for higher tax benefits could
and adverse crisis conditions in their post-crisis lending decisions (Danso
bias our findings that firms increase their financial leverage when board
et al., 2019). As such, although conditions improved, the insignificant
co-option increases. We therefore conduct several tests to assess whether
coefficient indicates that, on average, following the lending and regu
higher tax benefits could confound our co-option-leverage inferences.
latory changes during the crisis, a firm with non-co-opted directors re
We therefore follow Klasa et al. (2018) and augment our baseline
ceives more loans compared to its co-opted counterparts. Our results
specification regressing net leverage on the board co-option indicator to
remain unchanged when Co-optionTW is used as a regressor in place of
incorporate interactions between the indicator and the firm's marginal
Co-option. Overall, the evidence suggests that increased uncertainty and
tax rate (measured as in Blouin, Core, & Guay, 2010) and other proxies
vulnerability during the financial crisis induced CEOs in co-opted firms
for the existence of non-debt tax shields (depreciation/assets, tax loss
to develop strong risk aversion.
2
The Hansen J-statistics p-values are all in excess of 0.1, implying that the 5. Conclusions
over-identifying restrictions are valid (e.g., Baum, Schaffer, & Stillman, 2003).
Also, the Kleibergen-Paap rk Wald F statistics, compared with the Stock-Yogo IV The economics of director appointment and corporate financial de
critical values, rule out weak instrument problems; they are all larger than the cisions are highly multifaceted relative to the conventional and broadly
rule-of-thumb minimum of 10 (Baum, 2006). employed measures of corporate governance such as board
14
independence. Director co-option, by means of commitment and hom Alti, A. (2006). How persistent is the impact of market timing on capital structure? The
Journal of Finance, 61(4), 1681–1710.
age to the CEO who is involved in the process of director selection, may
Altuntas, M., Berry-Stölzle, T. R., & Wende, S. (2015). Does one size fit all? Determinants
inherently affect the directors' actions and discretion. Where directors of insurer capital structure around the globe. Journal of Banking & Finance, 61,
are chosen by a CEO, they become more supportive of that CEO, 251–271.
regardless of whether they are legally or conventionally independent. In Balsmeier, B., Fleming, L., & Manso, G. (2017). Independent boards and innovation.
Journal of Financial Economics, 123(3), 536–557.
this study, we examine whether board co-option drives capital structure Baltagi, B. (2008). Econometric analysis of panel data. John Wiley & Sons.
choice and further test the monitoring effectiveness of non-co-opted Baum, C. F., Schaffer, M. E., & Stillman, S. (2003). Instrumental variables and GMM:
independent directors and co-opted independent directors on capital Estimation and testing. The Stata Journal, 3(1), 1–31.
Baysinger, B., & Hoskisson, R. E. (1990). The composition of boards of directors and
structure decisions. strategic control: Effects on corporate strategy. Academy of Management Review, 15
Drawing on agency theory and using a variety of analytical ap (1), 72–87.
proaches, we find that firms with co-opted boards exert a positive and Berger, P. G., Ofek, E., & Yermack, L. (1997). Managerial entrenchment and capital
structure decisions. The Journal of Finance, 52(4), 1411–1438.
significant influence on the firms' financial leverage. We also find co- Blouin, J., Core, J. E., & Guay, W. (2010). Have the tax benefits of debt been
opted independent directors to be positively and significantly associ overestimated? Journal of Financial Economics, 98(2), 195–213.
ated with financial leverage, suggesting that co-option weakens the Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic
panel data models. Journal of Econometrics, 87(1), 115–143.
effective monitoring, thereby increasing a firm's leverage ratio. How Bruynseels, L., & Cardinaels, E. (2014). The audit committee: Management watchdog or
ever, boards with a high proportion of non-co-opted independent di personal friend of the CEO? The Accounting Review, 89(1), 113–145.
rectors have a negative influence on firms' leverage ratios, suggesting Cavaco, S., Crifo, P., Rebérioux, A., & Roudaut, G. (2017). Independent directors: Less
informed but better selected than affiliated board members? Journal of Corporate
that non-co-opted independent directors appear to be effective monitors.
Finance, 43, 106–121.
The results therefore appear consistent with the conclusion drawn by Chaivisuttangkun, S., & Jiraporn, P. (2021). The effect of co-opted directors on firm risk
Coles et al. (2014), indicating that not all independent directors are during a stressful time: Evidence from the financial crisis. Finance Research Letters,
effective monitors. Our results show that independent directors tend to 39, 101538.
Chang, Y.-K., Chou, R. K., & Huang, T.-H. (2014). Corporate governance and dynamics of
influence corporate financial decisions differently. Further analysis in capital structure: New evidence. Journal of Banking and Finance, 48, 374–385.
dicates that firms with co-opted boards adjust towards target leverage Chen, D. (2012). Classified boards, the cost of debt, and firm performance. Journal of
levels at a faster speed, with a half-life within a year for book and market Banking & Finance, 36(12), 3346–3365.
Chintrakarn, P., Jiraporn, P., Sakr, S., & Lee, S. M. (2016). Do co-opted directors mitigate
leverage. managerial myopia? Evidence from R&D investments. Finance Research Letters, 17,
An important implication of our results is that board independence, a 285–289.
conventional measure of board effectiveness, appears not to be sufficient Coles, J. L., Daniel, N. D., & Naveen, L. (2014). Co-opted boards. The Review of Financial
Studies, 27(6), 1751–1796.
to measure board effectiveness. Our results demonstrate clearly that the Dalton, D. R., Daily, C. M., Ellstrand, A. E., & Johnson, J. L. (1998). Meta-analytic
impact of independent directors appears to vary from one group of in reviews of board composition, leadership structure and financial performance.
dependent directors to another, implying that not all independent di Strategic Management Journal, 19(3), 269–290.
Danso, A., Lartey, T., Amankwah-Amoah, J., Adomako, S., Lu, Q., & Uddin, M. (2019).
rectors are effective monitors. One plausible explanation is that Market sentiment and firm investment decision-making. International Review of
independent boards may place more emphasis on monitoring managers Financial Analysis, 66, 101369.
while neglecting their advisory role (Coles et al., 2014). This clarifica Eisenberg, M. A. (1976). The structure of the corporation: A legal analysis. Washington, DC:
Beard Books.
tion is consistent with finance theory on the role of boards, which pre
Faleye, O. (2015). The costs of (nearly) fully independent board. Journal of Empirical
dicts that board independence is not always in the best interests of Finance, 32, 49–62.
stockholders, particularly where the board's advisory role is more Fama, E. F. (1980). Agency problems and the theory of the firm. Journal of Political
important than its monitoring role. Consequently, Schmidt (2015) ar Economy, 88(2), 288–303.
Fama, E. F., & Jensen, M. C. (1983a). Agency problems and residual claims. The Journal
gues that board independence can decrease firm value. Another impli of Law and Economics, 26(2), 327–349.
cation of our results is that firms with co-opted boards adjust their Fama, E. F., & Jensen, M. C. (1983b). Separation of ownership and control. The Journal of
capital structure towards target leverage levels at a faster speed, Law and Economics, 26(2), 301–325.
Flannery, M. J., & Rangan, K. P. (2006). Partial adjustment toward target capital
implying that a typical firm removes more than half of the effect of a structures. Journal of Financial Economics, 79(3), 469–506.
shock on its book and market leverage within a year upon board co- Fosu, S., Danso, A., Ahmad, W., & Coffie, W. (2016). Information asymmetry, leverage
option. and firm value: Do crisis and growth matter? International Review of Financial
Analysis, 46, 140–150.
Despite the significant contributions of this study that co-opted Fracassi, C. (2017). Corporate finance policies and social networks. Management Science,
boards exacerbate agency costs by weakening their oversight role over 63(8), 2420–2438.
executive management and that independent directors vary in terms of Fracassi, C., & Tate, G. (2012). External networking and internal firm governance. The
Journal of Finance, 67(1), 153–194.
their monitoring effectiveness in influencing capital structure decisions, Fresard, L. (2010). Financial strength and product market behavior: The real effects of
more studies appear warranted. Future studies should examine the corporate cash holdings. The Journal of Finance, 65(3), 1097–1122.
relationship between board co-option and corporate financial decisions Gamba, A., & Triantis, A. (2008). The value of financial flexibility. The Journal of Finance,
63(5), 2263–2296.
on a cross-country basis.
Gaud, P., Jani, E., Hoesli, M., & Bender, A. (2005). The capital structure of Swiss
companies: An empirical analysis using dynamic panel data. European Financial
Authors statement Management, 11(1), 51–69.
Gormley, T. A., & Matsa, D. A. (2016). Playing it safe? Managerial preferences, risk, and
agency conflicts. Journal of Financial Economics, 122(3), 431–455.
Details of each author’s contribution He, W., & Luo, J. H. (2018). Agency problems in firms with an even number of directors:
Theo Lartey: Conceptualization; Data Collection; methodology and Evidence from China. Journal of Banking & Finance, 93, 139–150.
Ho, P. H., Huang, C. W., Lin, C. Y., & Yen, J. F. (2016). CEO overconfidence and financial
Analysis crisis: Evidence from bank lending and leverage. Journal of Financial Economics, 120
Albert Danso: Conceptualization, methodology; original writing (1), 194–209.
Agyenim Boateng: Review and writing Hovakimian, A. (2004). The role of target leverage in security issues and repurchases.
The Journal of Business, 77(4), 1041–1072.
Hovakimian, A. (2006). Are observed capital structures determined by equity market
References timing? Journal of Financial and Quantitative Analysis, 221–243.
Hovakimian, G. (2011). Financial constraints and investment efficiency: Internal capital
allocation across the business cycle. Journal of Financial Intermediation, 20(2),
Acharya, V. V., Almeida, H., & Campello, M. (2007). Is cash negative debt? A hedging
264–283.
perspective on corporate financial policies. Journal of Financial Intermediation, 16(4),
Hovakimian, A., & Li, G. (2011). In search of conclusive evidence: How to test for
515–554.
adjustment to target capital structure. Journal of Corporate Finance, 17(1), 33–44.
Adams, R. B., Hermalin, B. E., & Weisbach, M. S. (2010). The role of boards of directors
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior,
in corporate governance: A conceptual framework and survey. Journal of Economic
agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360.
Literature, 48(1), 58–107.
15
Jiraporn, P., & Lee, S. M. (2018). Do co-opted directors influence dividend policy? Morellec, E. (2004). Can managerial discretion explain observed leverage ratios? The
Financial Management, 47(2), 349–381. Review of Financial Studies, 17(1), 257–294.
Klasa, S., Ortiz-Molina, H., Serfling, M., & Srinivasan, S. (2018). Protection of trade Morellec, E., Nikolov, B., & Schürhoff, N. (2012). Corporate governance and capital
secrets and capital structure decisions. Journal of Financial Economics, 128(2), structure dynamics. The Journal of Finance, 67(3), 803–848.
266–286. Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574–592.
Knippen, J. M., Palar, J., & Gentry, R. J. (2018). Breaking the mold: An examination of Nguyen, B. D. (2012). Does the Rolodex matter? Corporate elite’s small world and the
board discretion in female CEO appointments. Journal of Business Research, 84, effectiveness of boards of directors. Management Science, 58(2), 236–252.
11–23. O’Brien, J. P. (2003). The capital structure implications of pursuing a strategy of
Kochhar, R., & Hitt, M. A. (1998). Linking corporate strategy to capital structure: innovation. Strategic Management Journal, 24(5), 415–431.
Diversification strategy, type and source of financing. Strategic Management Journal, Ozkan, A. (2001). Determinants of capital structure and adjustment to long run target:
19(6), 601–610. Evidence from UK company panel data. Journal of Business Finance & Accounting, 28
Lartey, T., Kesse, K., & Danso, A. (2020). CEO extraversion and capital structure (1–2), 175–198.
decisions: The role of firm dynamics, product market competition, and financial Öztekin, Ö., & Flannery, M. J. (2012). Institutional determinants of capital structure
crisis. Journal of Financial Research, 43(4), 847–893. adjustment speeds. Journal of Financial Economics, 103(1), 88–112.
Lemmon, M. L., & Zender, J. F. (2010). Debt capacity and tests of capital structure Panousi, V., & Papanikolaou, D. (2012). Investment, idiosyncratic risk, and ownership.
theories. Journal of Financial and Quantitative Analysis, 1161–1187. The Journal of Finance, 67(3), 1113–1148.
Lim, J., Do, V., & Vu, T. (2020). Co-opted directors, covenant intensity, and covenant Schmidt, B. (2015). Costs and benefits of friendly boards during mergers and
violations. Journal of Corporate Finance, 64, 101628. acquisitions. Journal of Financial Economics, 117(2), 424–447.
Linck, J. S., Netter, J. M., & Yang, T. (2008). The determinants of board structure. Journal Stulz, R. (1990). Managerial discretion and optimal financing policies. Journal of
of Financial Economics, 87(2), 308–328. Financial Economics, 26(1), 3–27.
Linck, J. S., Netter, J. M., & Yang, T. (2009). The effects and unintended consequences of Westphal, J. D. (1999). Collaboration in the boardroom: Behavioral and performance
Sarbanes-Oxley act on supply and demand of directors. Review of Financial Studies, 22 consequences of CEO-board social ties. Academy of Management Journal, 42(1), 7–24.
(8), 3287–3328. Wilbanks, R. M., Hermanson, D. R., & Sharma, V. D. (2017). Audit committee oversight
Lu, J., & Wang, W. (2018). Managerial conservatism, board independence and corporate of fraud risk: The role of social ties, professional ties, and governance characteristics.
innovation. Journal of Corporate Finance, 48, 1–16. Accounting Horizons, 31(3), 21–38.
Mizruchi, M. S. (1983). Who controls whom? An examination of the relation between Zahra, S. A., & Pearce, J. A. (1989). Boards of directors and corporate financial
management and boards of directors in large American corporations. Academy of performance: A review and integrative model. Journal of Management, 15(2),
Management Review, 8(3), 426–435. 291–334.
16

16co-Opted Boards and Capital Structure Dynamics

Uploaded by

Copyright:

Available Formats

16co-Opted Boards and Capital Structure Dynamics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

16co-Opted Boards and Capital Structure Dynamics

Uploaded by

Copyright:

Available Formats

International Review of Financial Analysis 77 (2021) 101824

Contents lists available at ScienceDirect

International Review of Financial Analysis

Co-opted boards and capital structure dynamics

1. Introduction and appointment of directors on capital structure choice. Yet, in prac­

Research evidence supports the contention that competent monitoring is Table 1

+ (λβ3 )Xi,t− 1 × Cc,t− 1 + λωi + εi,t (4)

1 Co-opted Directors 1.00

International Review of Financial Analysis 77 (2021) 101824

(1) (2) (3) (4) (5) (6) (7) (8)

4. Results and discussion

Non-Co-opted-Indep − 0.060*** − 0.067*** − 0.017*** − 0.024*** − 0.016*** − 0.033*** − 0.009*** − 0.018***

(0.125) (0.049) (0.071) (0.031) (0.118) (0.046) (0.067) (0.028)

International Review of Financial Analysis 77 (2021) 101824

(1) (2) (3) (4) (5) (6) (7) (8)

Co-opted Directors 0.050*** 0.024*** 0.039*** 0.022***

(1) (2) (3) (4) (5) (9) (10) (12)

Co-OptionTW 0.064*** 0.053*** 0.020*** 0.016*** 0.020*** 0.027*** 0.012*** 0.012***

(1) (2) (3) (4) (5) (6) (7) (8)

Co-opted Directors 0.054*** 0.020*** 0.029*** 0.017***

International Review of Financial Analysis 77 (2021) 101824

(1) (2) (3) (4) (5) (6)

Co-opted Directors 0.080*** 0.018*** 0.066*** 0.022*** 0.053*** 0.013***

You might also like

1. Introduction and appointment of directors on capital structure choice. Yet, in prac

Non-Co-opted-Indep − 0.060* − 0.067* − 0.017* − 0.024* − 0.016* − 0.033* − 0.009* − 0.018*

Co-opted Directors 0.050* 0.024* 0.039* 0.022*

Co-OptionTW 0.064* 0.053* 0.020* 0.016* 0.020* 0.027* 0.012* 0.012*

Co-opted Directors 0.054* 0.020* 0.029* 0.017*

Co-opted Directors 0.080* 0.018* 0.066* 0.022* 0.053* 0.013*