Differentiated levels of corporate governance and the probability of violating financial covenants

Abstract

Corporate governance and financial covenants play complementary roles in monitoring companies as they reduce conflicts of interest between the parties involved when making debt contracts. This study expands this discussion by analyzing whether publicly traded Brazilian companies listed in B3's differentiated levels of corporate governance are less likely to violate financial covenants in an ex-post analysis of contract signing. The sample includes publicly traded non-financial Brazilian firms from 2010 to 2018, totaling 1,310 unbalanced panel observations for 206 companies. The data was obtained from Economatica, B³'s website and a hand collected database consisting of covenant information from the explanatory notes of the respective firms. Student’s mean t-test and a logistic regression analysis with year fixed effects were performed to calculate and analyze the results, which present evidence that companies listed on B3’s differentiated levels of corporate governance are less likely to violate financial covenants than other unlisted companies. This evidence suggests that B³ levels can be used as a proxy for governance in contractual contexts where there are conflicts of interest between the parties involved.