Impact of Corporate Governance on Bankruptcy Risk

Managerial Finance
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Abstract
The objective of this essay is to demonstrate the need of analyzing non-financial
information in addition to financial information by the investors for analyzing the default risk of
a business firm. In this context, the paper has specifically examined the impact of corporate
governance mechanisms on bankruptcy risks of business firms. This has been carried out by the
selection of about 10 credible research journal articles on the issue and comparing their findings
to derive specific results. The views and opinions of different authors presented in previous
researches have been analyzed in detail in the essay to analyze the research issue in an adequate
manner.
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Introduction
The business corporations develop and publish the financial statements for disclosing
their financial information and facilitating the decision-making process of the investors. The
analysis of the financial statements has been largely used by the investors for predicting the
probability of bankruptcy of firms. However, the reliability of the financial statements to predict
the future growth prospects of a firm has come under criticism since the occurrence of corporate
scandals such as Enron and Worldcom. These corporate scandals have highlighted that the
information disclosed within the financial statements are not reliable for taking major investment
decisions as they can be manipulated by the business managers for the sake of depicting higher
profitability of the firms. As such, it significant researches have been done on indentifying other
non-financial information in addition with the financial information that can be used for taking
investment decisions.
This is required so that the investment decisions are not merely based on the financial
information such as accounting ratios or stock price but also consider other factors that provide a
depiction of its internal environment. In this context, the present essay undertakes a literature
review in respect of the impact of the corporate governance on the bankruptcy risk. The existing
literature tends to find the importance of developing an efficient system of corporate governance
within a firm for reducing the risk of corporate failure. Although, the existing studies offer
evidences to support the relation between corporate governance and the risk of bankruptcy, yet it
need to be analyzed in detail for understanding that an adequate governance system internally
within a firm is essential to save a firm from the verge of bankruptcy.
Impact of Corporate Governance System on the Bankruptcy Risk
Several research studies have found evidence supporting the relation between the
corporate governance system of a firm and the risk of bankruptcy. In this context, Mokarami and
Motefares (2013) have adopted the use of various corporate governance measures such as board
size, CEO replacement and CEO dual position on the bankruptcy risk of a firm. As per the study,
the corporate governance system can be stated to be an established system of rules and
procedures that are used for developing a control system over the business procedures and
protecting the interest of the shareholders. The presence of an effective corporate governance
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