The Disciplining Role of Leverage in Dutch Firms

Abe De Jong

Review of Finance, 2002, vol. 6, issue 1, 31-62

Abstract: In this study we investigate the role of leverage in disciplining overinvestment problems. We measure the relationships between leverage, Tobin's q and corporate governance characteristics for Dutch listed firms. Besides, our empirical analysis tests for determinants of leverage from tax and bankruptcy theories. Representing growth opportunities, q is expected to be an agency-based determinant of leverage. Simultaneously,q represents firm value, which is determined by leverage and governance structures. We tes a structural equations model in which we deal with this simultaneous nature of the relation between leverage and q. Our results indicate that Dutch managers avoid the disciplining role of debt, when they are most likely to overinvest. Leverage is mainly determined by tax advantages and bankruptcy costs. In addition, we test the impact of leverage on excess investment.We do not find a difference in the influence of leverage on investment between potential overinvestors and other firms. This confirms that the disciplinary role of leverage in Dutch firms is absent. JEL classification code: G32

Date: 2002
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