Corporate governance reforms, societal trust, and corporate financial policies

While formal institutions are considered important in affecting corporate behaviors, little attention has been paid to the role of informal institutions in such relation. We employ the (formal) corporate governance reforms and the (informal) individual countries' trust levels to examine how the informal institution moderates the impacts of the formal institution on corporate financial policies. Using a sample of 88,929 firm-year observations across 35 countries, we document a positive effect of corporate governance reforms on corporate financing and investment. More importantly, we find that the positive effect of the formal regulatory reforms is more pronounced with lower levels of informal country-level trust. Further analysis shows that corporate governance reforms lead to both lower under-and over-investment, and the effect is also stronger in low-trust countries. Our study sheds light on the interactive relation between corporate governance and trust and indicates that countries can offset the negative lack-of-trust effect on economic outcomes through formal regulatory reforms.

Automated summary

This study examines the relationship between corporate governance and trust and finds that formal corporate governance reforms have a positive impact on corporate financing and investment. The positive effect is even more pronounced in countries with lower levels of trust. The findings imply that countries can offset the negative impact of lack of trust on economic outcomes through formal regulatory reforms.