Does effective monitoring by the board of directors affect the relationship between global diversification and financial leverage?

Abstract

Research investigating the relationship between global diversification and financial leverage has produced mixed results. Some studies found that global diversification improves the firm’s debt capacity and, as a result, increases its degree of financial leverage. Other studies found that global diversification increases firm risk and, as a result, decreases its debt capacity and the degree of financial leverage. In this study, we suggest that monitoring by the board of directors and related committees moderates the relationship between global diversification and the degree of financial leverage. Specifically, in firms with vigilant (passive) monitoring, the relationship between global diversification and the degree of financial leverage is positive (negative). Using a sample of 6,188 firm-year observations over the period 2002 through 2006, we find support for the hypothesis.