See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/360116924

Corporate failure in the UK: An examination of corporate governance

reforms*

Article  in  International Review of Financial Analysis · April 2022

DOI: 10.1016/j.irfa.2022.102165

CITATIONS READS

0 50

3 authors:

Mohamed Elsayed Tamer Elshandidy

Queen's University Belfast Ajman University
7 PUBLICATIONS   8 CITATIONS    33 PUBLICATIONS   864 CITATIONS   

SEE PROFILE SEE PROFILE

Yousry Ahmed
University of Bristol
8 PUBLICATIONS   25 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Risk reporting View project

All content following this page was uploaded by Mohamed Elsayed on 22 April 2022.

The user has requested enhancement of the downloaded file.

 Corporate failure in the UK: An examination of corporate governance reforms*

International Review of Financial Analysis, Forthcoming

https://doi.org/10.1016/j.irfa.2022.102165

Mohamed Elsayed**

Queen’s University Belfast, UK

m.elsayed@qub.ac.uk

Tamer Elshandidy

Ajman University, UAE

t.elshandidy@ajman.ac.ae

Yousry Ahmed

Newcastle University, UK

yousry.ahmed@ncl.ac.uk

* We are grateful to Brian M Lucey (The Editor) and the anonymous referees for helpful comments and suggestions.
This paper has benefited from comments and suggestions from participants at the British Accounting and Finance
Association Conference (London, 2018), Accounting and Finance group discussions and seminars at the University of
Bristol School of Accounting and Finance (2019), Newcastle University Business School (2020), Alliance Manchester
Business School (2021), and Queen’s University Belfast Management School (2021). We thank Konstantinos
Stathopoulos, Laurence van Lent, Hervé Stolowy, Aydin Ozkan, Abhijit Sharma, Jon Temple, Chris Chapman, Ruby
Trinh, Kirak Kim, Mariano Scapain, Andrey Golubov, Sandy Klasa, Piotr Korczak, Jon Tucker, and Steven Young for
their helpful suggestions.

** Correspondence should be addressed to Mohamed Elsayed, Queen’s Management School, Queen’s University
Belfast, Room 02.010 Riddel Hall, 185 Stranmillis Road, Belfast, BT9 5EE, UK. Email: m.elsayed@qub.ac.uk

0
 Corporate failure in the UK: An examination of corporate governance reforms

Abstract
In the context of major corporate collapses, executive compensation, board network, gender
diversity and oversight committees have all received attention in a package of corporate governance
(CG) reforms that were recently issued in the UK. This paper examines whether these reforms of
CG can influence the likelihood of corporate failure (CF). It also investigates how efficient they are
when CF approaches. After controlling for variables that prior research shows to be related to CF,
we find that CF is less likely when a firm is characterized by a lower executive compensation, larger
size of the board’s social network, and smaller degree of the board’s managerial network. However,
board gender diversity and independence of oversight committees do not reduce the likelihood of
CF. We further observe that the explanatory power of these CG variables is significant but relatively
decreased as the time to CF closes. This implies that despite the capability of these variables to
render early warning alerts of CF, they are less helpful (efficient) as failure becomes closer. Our
results remain robust after a battery of sensitivity tests and addressing potential endogeneity
problems. Collectively, the evidence provided by our paper should be of interest to the UK’s
regulatory bodies (Financial Reporting Council) and legislators (the UK’s Parliament), since it shows
the practical implications of the UK’s CG Code and other governance regulations on reducing future
corporate collapses. This paper provides timely evidence-based insights to major recent structural
reforms aiming at proposing remedies to CG problems in the UK.

Keywords: Executive compensations, Board network, Gender diversity, Oversight committees,

Financial distress, Bankruptcy

JEL classification: G33, G34, G38

1
 “Whilst a range of factors contributed to Carillion’s collapse it is right that poor governance

practices are being highlighted as a key contributor […]. So would the new CG code have saved Carillion

from failure?”

Sophie Brookes, partner at Gateley Plc, asked.

1. Introduction
Over the years the UK CG Code (the Code) has evolved since it was first introduced by the

Cadbury Committee in 1992. The ultimate intention of the Code is to deliver success of companies.

However, high-profile scandals of inadequate governance leading to major business failures (e.g.,

Thomas Cook, Carillion, British Steel, and Patisserie Valerie) have prompted a recent intensified

debate about the nature and extent of the UK’s CG framework (FRC 2018; FT 2020; Accountancy

Daily 2020). Aiming to build trust in business, the Financial Reporting Council (FRC) introduced a

new Code, and accompanying guidance on board effectiveness (the Guidance), in July 2018. The

new Code has put essential focus on board network, diversity in gender (referred to as board softer

skills), the independence of oversight committees, and executive compensation (or remuneration)

in order to achieve effective and efficient governance that can promote corporate health. Similarly,

to address public concern over executive pay, which remains despite legislative reforms enacted by

Regulations (2013), the UK Parliament approved the Companies (Miscellaneous Reporting)

Regulations (2018) with a view to reforming CG.1

Thus, considering public concern in the UK about the link between CG and the possibility of

CF, the question of whether the new Code recommendations could have prevented major CFs such

as Carillion, or the possible reasons for continued CFs despite the CG reforms (which to the best

1 It is worth noting that the Code is not mandatory but rather provides provisions for good governance, with which the
company has the flexibility to comply or explain why it does not comply. Useful links for the new or revised Code and
related topics can be found on the FRC and ICAEW websites: https://www.frc.org.uk/directors/corporate-
governance-and-stewardship/uk-corporate-governance-code; https://www.icaew.com/technical/corporate-
governance/codes-and-reports/uk-corporate-governance-code. For an analysis of the Code and the Companies
(Miscellaneous Reporting) Regulations 2018, refer, for example, to the Ernst & Young release in July 2018 at:
https://www.ey.com/Publication/vwLUAssets/EY-2018-UK-Corporate-Governance-Code-and-new-
legislation/$FILE/EY-2018-UK-Corporate-Governance-Code-and-new-legislation.pdf
2
of our knowledge are novel in CF literature) motivate our study. Accordingly, our paper exmines

the link between a comprehensive set of CG reforms including executive compensation, board

(managerial and social) network, gender diversity and oversight (audit, remuneration and

nomination) committees and CF. We further examine the efficiency of these CG reforms when CF

approaches, to see the ability of governance to intervene in preventing or altering the course of

failure.2

According to the Telegraph, the number of CFs in the UK hit a four-year high by 2018. In

July 2018, Paul George, Executive Director of Corporate Governance and Reporting – FRC, stated:

“Decline in public trust in business has been fueled in part by high-profile business failures such as BHS and Carillion

... The publication of a new UK CG Code raises the bar for UK businesses ...” In spite of this high level of

CFs, the concern to improve the CG system in the UK, and the public interest, there is noticeably

limited empirical evidence on the association between CG attributes and CF in the UK. In this, on

the one hand, the evidence concerning board structure and firm performance (Tosun, 2021;

Dedman, 2016), shareholder value (Orihara & Eshraghi, 2022), and board composition and CF (Hsu

& Wu, 2014), casts doubt on the CG recommendations suggested by UK regulators. On the other

hand, the extant evidence, mostly from the US, provides mixed findings and largely concerns the

conventional governance factors (i.e., board size, board independence, CEO power and the change

of CEO) (e.g., Fich & Slezak, 2008; Darrat et al., 2016). Thus, moving outside the US context (e.g.,

Short & Keasey, 1999; Cuomo et al., 2016) and analyzing unconventional governance factors that

would explain why a firm is less or more susceptible to failure remain an intriguing research area

(e.g., Platt & Platt, 2012; Tosun, 2021; Orihara & Eshraghi, 2022). This paper consequently

contributes to addressing this gap in the literature. Although the Code applies only to UK quoted

companies, our paper further expands the US-based literature in the area of CG and CF as follows.

2It might, however, be argued that focusing on one of these governance factors, as opposed to studying them together,
would be better for our research. The limitation of doing this, prima facie, is that some governance factors may
complement each other or may serve as substitutes. Thus, inferences induced from investigating one factor of
governance may be subject to an omitted variables bias (Ashbaugh-Skaife et al., 2006).
3
 First, prior research (e.g., Franks & Mayer, 2002; McCahery et al., 2002; Toms & Wright, 2005;

Fauver et al., 2017) indicates that UK companies are managed in a CG regime that has fundamental

differences to that prevailing in the US. Second, UK companies are managed under a less severe law

enforcement compared to the enforcement applied on US companies (Muñoz-Izquierdo et al.,

2019). Third, the UK is a less litigious environment than the US and the UK’s regulators (e.g., FRC)

have less enforcement power than their counterparts in the US (e.g., SEC or PCAOB) (Lennox et

al., 2019). Therefore, managers of UK companies are less likely to be concerned about litigation

exposure and regulatory sanctions which would affect CG differently, compared to the situation the

US. Lastly, the results from expanding the analysis to a different environment, the UK, where the

insolvency law is creditor-friendly, compared to the US’s Chapter 11 debtor-friendly code, is a

necessity to take a new look at evidence that stems from the US (e.g., Franks et al., 1996; Toms &

Wright, 2005; Davydenko & Franks, 2008; Senbet & Wang, 2012). Considering the similarity of the

underlying structure of the capital markets and companies in the US and the UK, it seems reasonable

to see the novelty of contribution provided by our paper as an expansion of the US-based literature

in the area of CG and CF.

The effectiveness of CG characteristics in preventing or predicting CF has been one of the

interests of prior studies (e.g., Fich & Slezak, 2008; Robinson et al., 2012; Platt & Platt, 2012; Hsu

& Wu, 2014; Darrat et al., 2016). Specifically, the key areas that lack attention in the prior literature

are: (1) there is no comprehensive test of the impact of CG characteristics under both financial and

legal approaches to CF; (2) the probable role of a firm’s CG in relation to CF is not theorized; (3)

most prior studies have restricted samples and employ CG variables while ignoring firm-specific

characteristics; (4) results from many prior studies are subject to bias attributable to using static

models (Shumway 2001), and/or possibly endogenous CG variables (e.g., Ashbaugh-Skaife et al.,

2006). Our paper addresses the gaps in previous literature by investigating how unconventional CG

variables, namely, executive compensation, board network, gender diversity and oversight

4
committees can influence the probability of CF using both legal and financial approaches.3 Adopting

the two approaches is advantageous for considering the practical perspectives of CF and thus,

improves the scope and predictive power of the empirical models (Campbell et al., 2008; Tinoco &

Wilson, 2013).4 We employ both agency and social network theories to interpret our empirical

results. We further control for various variables expressing firm-specific and external characteristics

(including accounting, market, and macroeconomic indicators), the tone in managerial disclosures,

and the conventional CG factors used in prior CF research, as well as endogeneity concerns in our

empirical models.

Our findings suggest that CF is less likely when a firm is characterized by a larger size of the

board’s social network, smaller degree of the board’s managerial network, lower executive

compensation, and a non-independent nomination committee. The evidence we find suggests that

board gender diversity and independence of oversight committees are less likely to reduce the

likelihood of CF, casting doubt on their effectiveness as monitoring functions. In addition, our

results show that the explanatory power of CG variables is significant but relatively lowered (by

about half) as the time to CF decreases. This implies that despite the capability of CG variables to

render early warning alerts of CF, CG practices are less likely to efficiently intervene to save firms

on the verge of failure. Our findings remain robust after (1) using alternative measures of oversight

committees and gender diversity; (2) considering endogeneity problems that attributable to self-

selection bias, simultaneity between CG variables and CF and/or omitted variables; (3) probing

results’ stability to influences of dividend policy and financial crises; (4) recognizing financial distress

and bankruptcy risk measures separately.

3 Our empirical models also control for conventional CG factors that are well documented in prior research, namely,
board size, board independence, board ownership, CEO power and the change of CEO, since they are included in the
Code. This would be also of interest to observe the plausibility of the US’s findings on conventional CG factors relative
to the UK.
4 Technical insolvency (financial distress) and legal insolvency (bankruptcy) describe the practical definitions used for

CF in the UK. See, for example, https://www.businessrescueexpert.co.uk/insolvency-vs-bankruptcy-uk/. Throughout

the paper, CF refers to financial distress and bankruptcy risks. Section 3 gives more details about the CF definition
employed in this paper.
5
 Our paper provides several contributions to literature on CF and CG as follows. We extend

CG literature by adopting the agency theory to explain the unconventional governance factors that

would predispose a firm to failure. This helps to answer a pending question in the literature (for a

review see, Gillan, 2006 and Cuomo et al., 2016) regarding whether, and how, CG internal factors

(e.g., management and directors) and external factors (e.g., managerial and social networks, law and

regulation) affect firms’ prospects. This paper also addresses a question posed by Platt and Platt

(2012) about whether CG attributes are important antecedents of CF that add to the explanatory

power of traditional CF predictors. The incremental explanatory power of CG attributes (above and

beyond traditional CF predictors) that we observe in our examinations suggests the usefulness of

such attributes, particularly those of interest in this study, in improving the traditional CF prediction

models. By correcting for the possible econometric problem of endogeneity, our paper addresses an

apparent void in the literature on CG and CF (which disregards the endogeneity issue).5

Practically, the additional role of CG attributes in explaining the reasons behind CF and in

rendering early warning alerts is pivotal to assist interested parties (e.g., the FRC, UK Parliament,

companies’ stakeholders) to take either preventive or remedial decisions.6 Given the recent periods

of great uncertainty and tumult, it is thoughtful to consider our empirical evidence particularly useful

to help in rethinking the implications of CG practices amid the sudden and unprecedented level of

CF due to the Brexit and Covid-19 pandemic (e.g., Ding et al., 2021).7 Our evidence against the high

level of executives’ pay supports the UK’s related concerns which led to the enactment of

Regulations (2013, 2018). It, however, reveals a potential overemphasis on the importance of the

monitoring role that was first recommended by the Cadbury Report (1992, Para. 4.12) and recently

defined by the CG recommendations in the new Code. In addition, the new Code’s concern with

5 For example, Appiah and Chizema (2016) call for an extension of their research in the UK by considering the
endogeneity problem, as well as testing the links between the nomination committee and board diversity and the
likelihood of CF.
6 FRC indicates that it considers monitoring, reviews the Code, and periodically updates the Guidance in order to achieve

the best governance practice (refer to the DIRECTORS section at https://www.frc.org.uk/).

7 For example, stakeholders urged the UK government to rethink CG reforms drawn up in the wake of high-profile

collapses (FT 2021a). Besides, there was an increase in non-compliance with the Code during the pandemic (FRC 2021).
6
gender diversity on company boards should be seen as included for fairness and equality reasons,

but not for real effect on company endurance. Our paper further is timely to provide evidence-based

insights to the four recent reviews of the UK’s CG environment (Kingman 2018; Brydon 2019;

BEIS Select Committee 2019; CMA 2019) aiming at proposing remedies to CG problems in the

UK. Eventually, from a managerial perspective, our results, consistent with the Guidance, suggest

that directors with larger social networks, but smaller managerial networks can be more focused,

diligent and responsible in leading the firm during times of distress.

The remainder of this paper proceeds as follows. Section 2 discusses the theoretical

considerations, reviews relevant prior literature and develops the research hypotheses. Section 3

designs the research methodology including data description, measurement of variables and the

dynamic logit model formulation. Section 4 discusses the empirical results and robustness checks.

Section 5 presents the conclusion.

2. Theoretical foundations, relevant literature and hypothesis development

In the UK, the FRC adopts an agency theory perspective in developing the Code with the

remit to improve CG in UK publicly quoted companies and, thus, maintain the confidence of the

capital market. The Code recommends specific CG mechanisms as a basis for good governance

practice, supporting better management, and mitigating the risks that firms face. The agency

problems owing to the separation of ownership and management would, however, lead to firms

being run less efficiently and thus, reduce their value and arguably increase the probablilty of failure

(Dedman, 2016; Kyere & Ausloos, 2020). Platt and Platt (2012) argue that agency theory is a widely

accepted theory to explain the association between CG attributes and CF prediction. Although the

vast majority of previous studies do not pay attention to the theoretical considerations that link CG

to CF, our paper builds on the premises of agency theory to explain the possible associations

between CG attributes, particularly those of interest in this study, and CF as follows.

7
2.1. Executive compensation
Executives’ compensation has triggered much interest from scholars (e.g., Fernandes, 2008;

Mallin et al., 2015) and regulators (e.g., SEC 1992; Regulations 2013) especially subsequent to the

corporate scandals in the 2000s. Interestingly, the empirical evidence of the relationship between

executives’ compensation and firm performance, thereby the probability of CF, is not conclusive

and leaves a considerable controversy and void in the literature (Core et al., 1999; e.g., Brick et al.,

2006; Laksmana, 2008; Duffhues & Kabir, 2008; Fernandes, 2008; Duffhues & Kabir, 2008). The

present study fills this void by investigating the association between the level of executives’

compensation and the likelihood of CF.

In particular, due to the conflict of interest between shareholders and managers, as indicated

by agency theory, executives’ compensation as a governance mechanism has been designed to align

these interests (Brick et al., 2006; Ozkan, 2007; Mallin et al., 2015). Accordingly, compensation is

presumed to motivate executives to work more effectively, thereby boosting the shareholders’

wealth and enhancing the firm’s performance (Duffhues & Kabir, 2008; Laksmana, 2008). This

theoretical perspective, therefore, leads to a positive relationship between executives’ compensation

and firm performance (Fernandes, 2008) and arguably results in a negative association between the

level of that compensation and the probability of CF.

On the other hand, a large body of studies casts doubt on the positive relationship between

executives compensation and firm performance. In this context, Duffhues and Kabir (2008) fail to

find a positive relationship between executives’ compensation and firm performance; instead, their

tests indicate a significantly negative relationship. The findings of Brick et al. (2006) point out that

the excessive level of executives’ compensation is negatively associated with firm performance.

Furthermore, Brick et al. (2006) and Ozkan (2007) suggest that the link between executives’

compensation and firm underperformance is attributable an ineffective CG.

In sum, these empirical evidences are consistent with the suggestion of Core at al. (1999) that

executives in firms with greater agency problems can influence their compensation, which results in

8
firm underperformance. Therefore, the present study infers that the negative association between

executives’ compensation and firm performance would drive the firm to fail. This discussion leads

us to formulate the following hypothesis:

H1. Ceteris paribus, firms whose executives receive significantly high levels of compensation
are likely to fail.

2.2. Board network

Two types of board network are considered in our investigation, that is, board managerial

network and board social network. The empirical evidence on the role of board networking is

generally limited. Particularly, investigating the role of board managerial networks (the number of

directors who have direct links with the firm’s board members, e.g., Crespí-Cladera & Pascual-

Fuster, 2015) in relation to CF is important for the following reasons. Kim (2005) suggests that a

large board managerial network might be detrimental to firm performance. Since, it can trigger an

agency problem, an impediment to the role of independent directors and decision-making

insufficiency. Furthermore, consistent with agency theory and the managerial power approach, large

directors’ managerial networks can result in lower monitoring, which can be exploited to the

detriment of the shareholders’ wealth (Arye & Fried, 2003; Kirchmaier & Stathopoulos, 2008;

Renneboog & Zhao, 2011). Under this managerial opportunism perspective, directors are more

likely to make a cohesive professional network and to be more beholden to management seeking

reciprocity while being able to avoid sanctions from the directorate network (Zona et al., 2015).

Overall, a large board managerial network is expected to negatively impact board

independence and firm performance, thereby increasing the probability of CF (Core et al., 1999;

Fich & Slezak, 2008; Crespí-Cladera & Pascual-Fuster, 2015). Thus, consistent with agency theory

and the managerial power approach, our study expects a positive association between the size of

board’s managerial network and the likelihood of CF.

By contrast, evidence regarding the consequences of directors’ social network activities

suggests an opposite outcome. Specifically, social network theory indicates that the degree to which

9
directors have a social network environment (which is amassed over the lifetime in employment,

education and other activities) can lead to greater access to information flowing in the network and

exchange of knowledge, decreasing information asymmetries, as well as enhancing financial

outcomes (Kirchmaier & Stathopoulos, 2008; Crespí-Cladera & Pascual-Fuster, 2015). Therefore,

social networks can boost the firm’s performance by allowing access to external knowledge and

financial resources (Boyd et al., 2011). This informational advantage derived from social ties enables

the firm to create new ties, and thence to enhance its capabilities (Gulati, 1995). As a result, social

network theory posits how the social capital of board members can improve the firm’s chances of

survival and success (Boyd et al., 2011). Thus, following social network theory, a negative

relationship between the board’s social network size and the likelihood of CF is predicted.

To the best of our knowledge, the effects that board networks may have on CF remain

unexplored. In addition, with these different foci and the competing predictions that agency and

social network theories offer,8 we contribute to CF and network analysis literature by advancing a

second hypothesis as formulated below:

H2. Ceteris paribus, firms with large board’s managerial network (social network) are more (less)
likely to fail.

2.3. Board gender diversity

With regard to agency theory, prior literature (e.g., Nguyen et al., 2021; Carter et al., 2003)

argues for the importance of gender diversity in the boardroom as a mechanism to monitor and

control managers. In this, board gender diversity findings are mainly linked to firms’ performance

and risk (e.g., beta or stock return volatility), where results are mixed. For example, a group of studies

(e.g., Perryman et al., 2016; Green & Homroy, 2018) find a positive (negative) association between

gender diversity and firm performance (risk). While another group (e.g., Adams & Ferreira, 2009;

Sila et al., 2016) find conflicting or no evidence on that association. Studying the relation between

8 In a different but related context, Zona et al. (2015) recognize agency and resource dependence theories to reconcile
the contradictory findings regarding the relationship between board networks and firm performance.
10
several CG variables and bankruptcy risk for a sample of the US firms, Darrat et al. (2016) find

marginal evidence that firms with more gender-diversified boards are less likely to go bankrupt.

Employing a sample of UK private companies during 2007-2008, Wilson and Altanlar (2011) show

inconclusive evidence that board gender diversity reduces insolvency risk. As we are not aware of

other empirical work, our exploration to the UK public companies is a breakthrough in this research

area (see a review of Terjesen et al., 2009).

Accordingly, the present study, following Darrat et al. (2016) and the first group of studies on

firm performance and risk, expects a negative relationship between board gender diversity and CF.

Our third hypothesis, thus, posits that:

H3. Ceteris paribus, firms with a greater level of diversity in board gender are less likely to fail.

2.4. Oversight committees

Oversight committees, including Audit, remuneration and nomination committees, could

generally be viewed as the most powerful side among boards of directors (Platt & Platt, 2012).

Previous research on the US firms (e.g., Daily et al., 1998; Elloumi & Gueyie, 2001) recognizes audit,

remuneration and nomination committees as key monitoring mechanisms and provides evidence to

support the independence of these committees in order to protect shareholders’ interests, detect

causes of performance decline as early as possible. In this context, Carcello and Neal (2000) expect

that independent audit committee is likely to mitigate management pressure on the auditor,

particularly for financially distressed firms. Platt and Platt (2012) show that independent nomination

committee would be more effective in reducing the risk of bankruptcy. In addition, previous studies

(e.g., Elloumi & Gueyie, 2001; Platt & Platt, 2012; Darrat et al., 2016) suggest a negative association

between the independence of audit and remuneration committees and the likelihood of CF.

Empirical evidence apparently is exclusive to the US setting and supports the independence

of oversight committees. Besides, considering for example the doubt recently shed by the CMA

report (2019) on the effectiveness of the audit committees in the UK. Investigating the association

between the independence of oversight committees and the probability of CF in the UK sounds,

11
therefore, interesting and important. Accordingly, and based on this discussion, this paper expects

a negative relationship between the independence of each oversight committee and the likelihood

of CF, and thus formulates the fourth hypothesis as follows:

H4. Ceteris paribus, firms with independent oversight committees are less likely to fail.

3. Methodology
3.1. Sample selection
The CG of UK publicly quoted companies is reviewed periodically by FRC and as a result, it

introduces a set of recommendations as a basis for the best practice of CG (known as the Code).

Salient to the background of this study is that FRC recommendations (CG reforms) are constituted

on the observed CG practices. That is, CG reforms are not exogenous to the publicly quoted

companies, however, there is a variation of compliance with the arguably best practice of CG.

Accordingly, to investigate the possible effectiveness of CG reforms in relation to CF, following

previous studies (e.g., Charitou et al., 2004; Elsayed & Elshandidy, 2020), our sample contains Public

Limited Companies (PLCs) whose shares are publicly traded under the UK Companies Act 2006,

and Alternative Investment Market (AIM) companies.

Our sample covers a period of sixteen years (January 2000-December 2016) because CG data

starts to be available on the BoardEx database (which we use to compile the CG data) in 1999, and

2016 to ensure that the healthy firms did not become failing over the next two years (e.g., Shumway,

2001). It also is important to end our sample in December 2016 for three other main reasons. First,

to avoid results bias due to the unusual Brexit events after 2016 through 2020 leading to the UK’s

exit from the European Union that has generated a large, broad and long-lasting uncertainty in the

UK market, persistent up to three years after the vote in 2016 (e.g., Davies & Studnicka, 2018; Bloom

et al., 2019; Hassan et al., 2019; 2021). Second, to avoid results bias due to the unprecedented market

volatility, unexplained trading activities, and abnormal impacts on the CG and market data related

to the COVID-19 pandemic, where the UK market index has seen the biggest decline since the

financial crisis and fallen about 15% during the pandemic (FT 2021b, 2021c; Hassan et al., 2020;

12
Doxey et al., 2021). Third, and along these lines, to avoid measurement error endogeneity bias

resulting from the atypical CF incidents in the UK after 2016 through 2020 as a consequence of

Brexit and COVID-19 pandemic rather than CG attributes (FRC, 2018; FT, 2020; Accountancy

Daily, 2020).

Failed firms, therefore, includes observations only for firms that failed during our sample

period, as reported by the Bloomberg database and the Companies House – GOV.UK

(gov.uk/government/organisations/companies-house). Consistent with previous research (e.g.,

Darrat et al., 2016), we exclude financial firms with a Standard Industrial Classification Code (SIC)

between 6000 and 6999 because of their distinctive regulations and accounting practices. These

procedures result in a final sample of 272 failed firms. In accordance with most previous CF

literature (e.g., Charitou et al., 2004; Hsu & Wu, 2014), we match the group of failed firms with a

group of 272 healthy firms based on firm size (measured by total assets specified from the last

complete filed account before CF) and SIC industry classification using the propensity score

matching method. This provides a systematic method to define our sample of healthy firms, thereby

controlling for self-selection bias.9 Accounting, market and macroeconomic data required in this

study are collected from Datastream and Thomson Banker (Worldscope) databases.

3.2. Research Design

Following Shumway (2001), Campbell et al. (2008) and Mayew et al. (2015), we employ a

dynamic logit model (also referred to as hazard or survival analysis) to test the effect of CG variables

on the likelihood of CF. Shumway (2001) illustrates that using static models in CF prediction results

in biases and overestimates of coefficients, and a decrease in efficiency. Thus, we use a dynamic logit

model that considers multiple years, instead of single firm-year observation, as in a static model, for

failed and healthy firms. Our final sample contains 272 failed firms with 1570 firm-year observations

9 Using a matched control sample also enables us to reduce the highly labor-intensive activity of the manual collection
of UK annual reports to retrieve unavailable data (e.g., qualitative data). In addition, we become able to trace the fate of
both sets of the failed and healthy firms to assure that the latter did not become failing over the next few years.
Observations related to failed firms are excluded after the event of failure (e.g., Shumway, 2001; see 3.2. The dynamic
logit model below).
13
and 272 healthy firms with 2371 firm-year observations. Specifically, we estimate a multiperiod logit

model where healthy firms are coded as zero in every year, while failed firms are coded as one in the

event of failure and zero in the prior years. Because there are multiple observations of the same firm,

we use robust standard errors estimation and adjust standard errors clustered by firm (Petersen,

2009). Thus, we estimate the probability of CF using the following multiperiod logit model:

1
Prob(CFi,t+1 "or" CFi,t+2 = 1) = (1)
1 + exp(−a − BXi,t )

CF is a binary dependent variable that takes the value of one in the event of corporate failure

and zero otherwise. Specifically, following Campbell et al. (2008) and Tinoco and Wilson (2013), we

adopt a CF definition that includes the legal approach and financial distress approach. A firm is

classified as legally failed when its status is under administrative receivership, administration,

company voluntary arrangement, voluntary liquidation, liquidation or when there is a cancellation

of the firm and it is assumed valueless, as reported by Bloomberg and the Companies House

databases (e.g., Charitou et al., 2004). A firm is classified as financially failed (in distress) whenever

it simultaneously experiences, for two consecutive years, the following conditions (e.g., Tinoco &

Wilson, 2013): first, negative growth in market value; second, its financial expenses surpass its

earnings before interest, taxes, depreciation, and amortization.10 Following prior studies (e.g.,

Tinoco & Wilson, 2013; Darrat et al., 2016; Elsayed & Elshandidy, 2020), we estimate the probability

of CF for one and two years before the event of failure.

Xi,t is a vector of time variate covariates that represent a linear combination of three main

types of explanatory variables. First, a set of ‘unconventional CG variables’ that are recommended

by the recent reforms, which are our main interest. Second, a set of CG control variables that are

broadly used in previous CF research, which we call ‘conventional CG variables’. Third, a set of

10 Notwithstanding the advantages of using this CF definition, as indicated earlier in Section 1, our inferences remain
qualitatively similar when we consider financial distress and bankruptcy separately. Besides, it is worth noting that healthy
firms include only non-failed firms that are not exposed to financial distress, to ensure the accuracy of our analyses.
14
accounting, market, macroeconomic, and qualitative variables that are shown as important

predictors of CF, which we call ‘benchmark variables’.

In particular, we use the following unconventional CG variables in our dynamic logit model:

Executives’ compensation (Exec_Comp) is measured as the log of the sum of executives’ salary and

bonus (e.g., Brick et al., 2006; Fernandes, 2008; Duffhues & Kabir, 2008).11 Board’s managerial

network (Manag_Net) for a director is the number of directors that have a direct link with her/him,

sitting on the same board (e.g., Crespí-Cladera & Pascual-Fuster, 2015). Thus, on the board level, it

is the log of the number of directors who have direct links with the firm’s board members. Board’s

social network (Social_Net) for a director is a cumulative variable that calculates the number of

direct ties created throughout the director’s lifetime (depending on BoardEx director and individual

profiles). Thus, on the firm level, the present study uses a comprehensive measure of Social_Net as

it is employed as a cumulative variable measuring the (log of) total number of overlaps in

employment, education and other activities amassed over the lifetime of the directors on the board.

As a result, this measurement permits more precise consideration of directors’ personal social

networks (Kirchmaier & Stathopoulos, 2008). Board gender diversity (Diversity) is captured by the

proportion of female directors on the board of directors (e.g., Adams & Ferreira, 2009). The

independence of each oversight committee (Aud_Ind, Rem_Ind, and Nom_Ind) is represented by

dummy variables with a value of 1 if the audit, remuneration or nomination committee is totally

composed of independent non-executives and a value of 0 otherwise (Darrat et al., 2016).

We also use conventional CG variables that prior research shows to be related to CF (e.g.,

Daily & Dalton, 1994, 1995; Daily et al., 1999; Elloumi & Gueyie, 2001; Parker et al., 2002; Fich &

Slezak, 2008; Platt & Platt, 2012; Elshandidy & Neri, 2015; Darrat et al., 2016). In doing so, we

control for Board Size (Board_Size) as measured by the log of the total number of board members;

11 In contrast to long-term compensation plans, salary and financial performance-based bonus are straightforward and
typically paid on an annual basis (Core at al., 1999). Additionally, using salary and bonus measure, compared to long-
term compensation plans, enables precise analysis and results interpretation since failed firms do not typically last for a
long period (Darrat et al., 2016).
15
Board Independence (Board_Ind) as measured by the proportion of independent non-executives to

the board size; Board Ownership (Board_Own) as proxied by concentrated ownership (closely held

shares), which is measured by the log of the percentage of shares held by officers, directors and their

families, or by any individual holding 5% or more of the outstanding shares (i.e., the percentage of

shares owned by firm insiders); CEO Turnover (CEO_Turn), a dummy variable coded as 1 if the

firm experienced a change in CEO and 0 otherwise; CEO duality (Duality) as measured using a

dummy variable set to 1 if the CEO is also chairperson of the board of directors or the executive

chairperson is present on the board and 0 otherwise. Following the above-mentioned studies, the

present study predicts a negative (positive) relationship between Board_Size, Board_Ind and

Board_Own (CEO_Turn and Duality) and the likelihood of CF.

Finally, following Tinoco and Wilson (2013) and Campbell et al. (2008) our benchmark

variables include: first, accounting variables: Profitability = net income/total assets, Liquidity =

current assets/current liabilities, Leverage = total debt/total equity capital, Performance = total

funds from operations/total liabilities; second, market-based variables: Price = log firm’s equity

price, Ab_Return = the firm’s cumulative annual returns minus the FTSE All Share return index for

the same period of time, Market_Cap = log the firm’s market capitalization relative to the total

market capitalization of the FTSE All Share index, MTB = market value equity to book value equity,

and Sigma = the mean of the volatility of market returns as a measure of total risk; third,

macroeconomic-based variables: RPI = Retail Price Index in base 100 as a measure of inflation rate,

and TBR = 3-Treasury Bill Rate as a proxy for interest rates; finally, following Mayew et al. (2015),

a qualitative information variable capturing management negative tone in annual report narratives is

used: Neg_Tone = the percentage of negative words in the annual report narratives, captured by an

automated textual analysis using Loughran and McDonald’s negative wordlist. Consistent with prior

research, the present study predicts positive (negative) association between Leverage, MTB, Sigma,

RPI, TBR, and Neg_Tone (Profitability, Liquidity, Performance, Price, Ab_Return, and

Market_Cap) and the probability of CF.

16
 Next, to test our second research question of how efficient are the unconventional CG

variables in preventing or altering the course of failure in one and two years before the CF event,

we employ sevral research methods adopted by previous studies (e.g., Ashbaugh-Skaife et al., 2006;

Campbell et al. 2008; Mayew et al. 2015; Darrat et al. 2016; Elsayed & Elshandidy, 2020). Specifically,

we use the McFadden Pseudo R2 (Pseudo R2), as well as the p-value of likelihood ratio test statistics

(LRT) and Area Under the Receiver Operating Characteristic (ROC) Curve (AUC) to examine the

effectiveness of the unconventional CG variables when CF approaches (i.e., moving from two years

prior to CF to one year prior to CF). Higher statistic estimates of Pseudo R 2 and AUC in addition

to the significance of p-value of LRT denote the incremental explanatory power of CG variables

and model goodness of fit.

4. Empirical Results
4.1. Descriptive Statistics
Table 1 reports descriptive statistics for all independent variables, displaying the entire dataset

of 3941 firm-year observations. Consistent with prior research (Darrat et al., 2016), we winsorize all

continuous variables at the 1% and 99% levels to mitigate the statistical problem of outliers. As

expected, and in line with prior studies (e.g., (Hsu & Wu, 2014), the descriptive statistics, on average,

indicate that both healthy and failed firms significantly experience differences (based on t-test) in

terms of their CG attributes and economic variables (untabulated for brevity). Given the limitation

of univariate test results and the importance of assessing the evidence related to the effect of each

variable without isolation of other variables (e.g., Shumway, 2001), we turn our inferences to the

multivariate analysis discussed later.

[Insert Table 1]
Table 2 reports the Spearman’s rho correlations among the independent variables and CF

indicator variable, where, as mentioned before, CF is coded as one if the firm is classified as failed

and zero otherwise. The CF indicator variable is negatively correlated with all unconventional CG

variables. In addition, CF indicator variable is significantly negatively (positively) correlated with

Board_Size, Board_Ind, Profitability, Liquidity, Performance, Price, Market_Cap, Ab_Return, and

17
MTB (Board_Own, CEO_Turn, Sigma, TBR, PRI, and Neg_Tone). Qualitatively, these directions

are consistent with our predictions. As expected, unconventional CG variables are also significantly

correlated with each other and with most control variables. Additionally, several correlations

between various variables are above 0.5. Therefore, Spearman coefficients for explanatory and

control variables included in the dynamic logit analyses are also employed to diagnose

multicollinearity. With variance inflation factor (VIF) statistics less than 10, ranging between 1.05 to

3.99, the unreported tests indicate that multicollinearity is not a concern (Field, 2013).

[Insert Table 2]

4.2. CG reforms’ effect and efficiency on the probability of CF

Table 3 reports the results of dynamic logit regression models for examining how CG reforms

are linked to the probability that a firm could fail within a year and two years. In Model 1 and Model

3 for one and two years prior to CF, respectively, we investigate the role of unconventional CG

variables (which represent our main variables of interest, including: Exec_Comp, Manag_Net,

Social_Net, Diversity, Aud_Ind, Rem_Ind, and Nom_Ind) in the likelihood of CF. The results, on

average, indicate that CF is much less likely (Z-statistics are -2.830 and -3.056 at the 1% significance

level in both tests for t - 1 and t - 2, respectively) when a firm is characterized by larger board’s social

network. Assessing the economic significance, the unreported marginal effects of Social_Net

variable are -0.012 and -0.016 for t - 1 and t - 2, respectively. This indicates that a one-standard-

deviation increase in the Social_Net variable (0.773) is related to a -9.9% (-0.012 * 0.773 / CF binary

dependent sample mean of 0.094) decline in the likelihood of CF within one year. Similarly, a one-

standard-deviation increase in Social_Net is associated with a 13.2% decline in the likelihood of CF

within two years. These empirical results lend support to the second hypothesis. This finding is in

line with social network theory, which suggests that the larger the social network amassed over the

director’s lifetime, the greater is the director’s ability and talent to manage a firm safely and prevent

CF.

[Insert Table 3]

18
 On the other hand, Model 1 and Model 3 suggest that CF is likely when executives receive an

increased level of compensation (Z-statistics are 2.057 and 2.181 at the 5% significance level in t - 1

and t - 2, respectively), as well as when the board’s managerial network is larger (Z-statistic is 2.744

at the 1% significance level in t - 2). From an economic perspective, the unreported marginal effects

of the Exec_Comp (Manag_Net) variable is 0.006 and 0.007 (0.024) in t - 1 and t - 2, respectively.

This demonstrates that a one-standard-deviation increase in the Exec_Comp (Manag_Net) variable

is associated with a 12.5% and 14.6% (39.2%) greater likelihood of CF within one year and two

years, respectively. Overall, these results support the first and second hypotheses. These results

accord with agency theory and the managerial power approach (e.g., Arye & Fried, 2003) suggesting

that the larger degree of the directors’ managerial network can cause lower monitoring that would

result in firms’ underperformance (Kirchmaier & Stathopoulos, 2008; Renneboog & Zhao, 2011;

Crespí-Cladera & Pascual-Fuster, 2015). These findings also suggest the negative impact of high

executive pay and are consistent with previous empirical studies (e.g., Brick et al., 2006) finding that

executives’ compensation is negatively related to firm performance, and in turn, leads to CF.

In terms of the Diversity variable, results reported under Model 1 and Model 3 suggest that

board gender diversity is statistically insignificant and thus, do not support the third hypothesis. This

finding, however unexpected, does not surprise us because it is consistent with literature on the

association between board gender diversity and firm’s risk and performance (e.g., Adams & Ferreira,

2009; Sila et al., 2016). Specifically, in line with prior literature (e.g., Adams & Ferreira, 2009; Sila et

al., 2016), we find no association between the proportion of female directors on corporate boards

and firms’ likelihood of failure.

Turning to oversight committees under the same Models 1 and 3, surprisingly, the results

show that CF is likely when the nomination committee (Nom_Ind) is independent (Z-statistics are

2.054 and 2.011 at the 5% significance level in both tests for t - 1 and t - 2, respectively). The

unreported marginal effects of the Nom_Ind variable of 0.030 and 0.031 in t - 1 and t - 2 suggest

that a one-standard-deviation increase is related to a 12.3% and 12.7% greater likelihood of CF

19
within one year and two years, respectively.12 The results related to audit and remuneration

committees generally appear not to be statistically significant. This finding opposes the argument

that supports the audit committee as a strong governance mechanism (Cohen et al., 2002). It is

consistent with the results in the UK context suggesting an insignificant or positive association

between the nomination committee and CF (Appiah & Chizema, 2016) and that firms with a greater

proportion of independent directors who are serving concurrently on multiple oversight committees

are more likely to fail (Hsu & Wu, 2014). It also extends the conclusion of Dedman’s (2016) evidence

against the FRC monitoring view censuring CEO-to-chair moves and Hsu and Wu’s (2014) finding

that the likelihood of CF is positively associated with the proportion of independent non-executives

on the board in the UK’s nonfinancial quoted companies. Thus, the finding on oversight committees

does not support the fourth hypothesis.

Model 2 and Model 4 include further CG indicators (i.e., conventional CG variables of

Board_Size, Board_Ind, Board_Own, CEO_Turn and Duality), which were of interest in previous

CF studies (mentioned earlier). Using these CG indicators as further control variables helps to

address the possible identification problem posed by unobservable correlated variables, as well as to

observe the plausibility of the US’s findings relative to the UK. Model 2 and Model 4 for one year

and two years before CF support inferences derived from Model 1 and Model 3, respectively. They

show that Exec_Comp, Manag_Net, Social_Net, and Nom_Ind are powerful and consistent

variables related to the possibility of CF, even in the presence of conventional CG variables.

Meanwhile, Diversity, Aud_Ind, and Rem_Ind remain lacking in statistical significance. In sum, this

emphasizes the implications that our findings have for both theory and practice.

Regarding conventional CG variables, interestingly (with a salient insignificant LRT p-value

as shown in Model 4) none is statistically significant in its association with the likelihood of CF,

12 An explanation for the positive association between the non-independent nomination committee and the lower
likelihood of CF is that, as opposed to independent directors, affiliated directors may be more knowledgeable about the
firm, which would enable them to hire more suitable directors who can effectively manage the firm, especially during
times of distress.
20
either for the penultimate year or the year preceding the CF. Only for one-year prior to CF,

CEO_Turn is statistically significant at the 1% level (Z-statistic of 2.828 and unreported marginal

effects of 0.032), which suggests that CEO instability is higher in failed firms (Daily & Dalton, 1995;

Parker et al., 2002). Overall, the present study’s results related to the conventional CG variables, as

well as the oversight committees, are consistent with the findings of Hsu and Wu (2014) related to

board composition in the UK context. The implications are two-fold. First, the US’s CG findings

would probably not be feasible relative to the UK. Second, the monitoring function is apparently

ineffective in the UK context and drives firms to be more susceptible to failure. Finally, consistent

with our predictions and prior CF literature (e.g., Tinoco & Wilson, 2013), results for the benchmark

control variables indicate that Leverage, Sigma, RPI, TBR, and Neg_Tone (Profitability, Price,

Ab_Return, and Market_Cap) positively (negatively) relate to the likelihood of CF.

We next examine the efficiency of unconventional CG variables when CF approaches,

checking their ability to intervene in preventing or altering the course of failure. It is notable that

the addition of the unconventional CG variables raises the Pseudo R2 statistic by 4% (from 0.199

for an unreported model containing the benchmark variables to 0.207 for Model 1) for the year prior

to CF, whereas in two years prior to CF, adding unconventional CG variables raises the Pseudo R 2

statistic by 7.2% (from 0.181 for an unreported model containing the benchmark variables to 0.194

for Model 3). This finding is consistent with prior literature (e.g., Darrat et al. 2016) showing that

the explanatory power of CG indicators is relatively raised as the period to CF increases. Put

differently, this finding indicates that the efficiency of the unconventional CG variables is lessened,

by, 44.4%, almost half (from 7.2% to 4%), when CF approaches (in our case, from t - 2 to t - 1).

Additionally, LRT’s p-values reported under Model 1 and Model 3 to test the joint significance of

the incremental explanatory power provided by unconventional CG variables (relative to or beyond

that offered by benchmark variables) for one year and two years prior to CF, respectively, are

statistically significant at the 1% level. AUC displays good model performance (i.e., good

discriminating ability). We further get consistent results from Models 2 and 4.

21
 Altogether, the theoretical implications of these results stem from the distinctive role of

unconventional CG variables in explaining CF and show the importance of considering these

variables when studying CF prediction, particularly over a relatively prolonged period. Practically,

our results support the UK’s regulatory trend against high executive pay, which led to the legislation

of Regulations (2013, 2018). From a managerial perspective, the results suggest that directors with

larger social networks, but smaller managerial networks, can be more focused, diligent and exercise

superior responsibility in leading the firm during times of distress. The Code assertion on gender

diversity on company boards should be seen as intended for fairness and equality reasons, but not

for real effect on company endurance. Our evidence related to the oversight committees also reveals

a potential overemphasis on the effectiveness of the monitoring role as recommended since the

Cadbury Report (1992, Para. 4.12) and defined by the CG provisions in the new Code.

4.3. Robustness checks

4.3.1. Using alternative measures of oversight committees and gender diversity
With respect to our previous results regarding the ineffective role of the oversight committees,

we relax our measure of the independence of the oversight committees by expressing independence

as the proportion of independent non-executives relative to each committee’s size (Platt & Platt,

2012), instead of our dummy indicators. Additionally, we strictly test our evidence showing the

insignificant association between female boardroom representation and CF by differentiating

companies with at least one female director from those without any, to inspect if board gender

diversity is irrelevant to CF (e.g., Sila et al., 2016). As shown in Table 4, except for Nom_Ind under

Models 1 and 2, which is positive and significant at the 5% level in the year preceding the CF and

the penultimate year, collectively the results appear not to be statistically significant. Thus, these

results are all very similar to our previous findings. This also casts more doubt on the monitoring

function in the UK context, not only on the level of the board of directors as illustrated by Hsu and

Wu (2014), but also on the level of the oversight committees. That is, in turn, a further argument

22
against the efficacy of independent directors (e.g., Daily et al., 1999; Hsu & Wu, 2014; Darrat et al.,

2016), and board gender diversity (e.g., Adams & Ferreira, 2009; Sila et al., 2016).

[Insert Table 4]

4.3.2. Endogeneity tests

4.3.2.1. Simultaneity and omitted variables (Dynamic logit and IV probit)
We consider the endogeneity problems that would arise from the reverse causality or

simultaneity between CG variables and CF and/or the omitted variables. Although endogeneity bias

is seen as a common concern in CG research (e.g., Larcker et al., 2007; Elshandidy & Neri, 2015),

most prior research on CG and CF assumes that CG factors are exogenous to CF. Nevertheless, it

is plausible to argue that the deterioration in the firm’s financial status may influence governance

constructs (i.e., reverse causation) aiming at avoiding legal bankruptcy. Additionally, in spite of our

careful research design, the unobserved determinants of management ability and effectiveness in

supervising the firm could be omitted variables that in one way or another are correlated with our

CG variables of interest. We, therefore, fill an apparent void in the literature on CG and CF by

accounting for endogeneity as follows.

To address the possible simultaneity problem, following prior research (e.g., Hoitash et al.,

2009; Elshandidy & Neri, 2015; Darrat et al., 2016), we pre-date the CG indicators predicting the

probability of CF two and three years in advance (i.e., employing CG in y=t-1 and y=t-2 to predict

the probability of CF in y=t+1). The dynamic logit results (untabulated for brevity) demonstrate

that our previous results are generally consistent and not prone to simultaneity concern.

Then, we employ an instrumental variables probit estimation (IV probit) to address the

possibility of omitted variables. Following prior research (e.g., Van Houtven & Norton, 2004;

Scellato & Ughetto, 2010; Correia, 2014) we run two sets of instrumental variables. The first set

(Models 1, 2, 5, and 6 of Table 5) uses the lagged values of the unconventional CG variables as

instrumental variables. Employing the lagged values as instrumental variables is in line with prior

research (e.g., Ashbaugh-Skaife et al., 2006; Larcker & Rusticus, 2010; Elshandidy & Neri, 2015;

23
Hassanein et al., 2019). The success of IV estimation depends on finding non-weak and valid

instrumental variables that are correlated with the endogenous regressor, without being correlated

with the error in the structural equation (otherwise, IV estimates can be badly biased and thus, the

regular logit or probit model should be followed) (e.g., Larcker et al., 2007). To attest these criteria,

following prior research (e.g., Larcker & Rusticus, 2010; Correia, 2014), Models 1-8 of Table 5 report

each model’s Cragg-Donald F statistic estimate, C (GMM distance) test p-value, and Wald test of

endogeneity p-value. All tests prove that our instruments are relevant and not weak.13

Models 1, 2, 5, and 6 of Table 5, prima facie, are exactly identified and thus, examining the

exclusion restriction (or so-called overidentifying restrictions test) is unfeasible. Therefore,

consistent with prior research (e.g., Correia, 2014), in Models 3, 4, 7, and 8 of Table 5, we add two

more instruments (the second set): the standard deviation of the number of qualifications of all the

firm’s directors over the same period, and the standard deviation of the time on board values of all

the firm’s directors over the same period. Using standard deviation is rational as it plainly expresses

how directors are qualified and/or endure the firm relatively farther or closer to the average (i.e., the

spread out from the expected value). In this form, these variables are unlikely to be associated with

the probability of CF and are expected to be related to our CG variables. Models 3, 4, 7, and 8 report

the overidentifying restrictions test estimates (based on Hansen J statistic) where we cannot reject

the null hypothesis that all instruments are valid (i.e., the instruments are exogenous). Collectively,

the findings reported by the IV probit regressions are consistent with the results of our main

13The unreported first-stage Shea’s partial R2 and partial F statistics (above the often-used threshold of 10) also confirm
the relevance of our instrumental variables. It is worth noting that we run IV probit using Newey’s (1987) two-equation
method. Our results are robust to implement the maximum likelihood estimation method (see Wooldridge, 2010). Since
both methods require the endogenous regressors to be continuous, the independence of the oversight committees is
expressed by the proportion of independent NEDs over each committee’s size instead of our dummy indicators.
24
analyses.14 This implies that inferences driven by our analyses are not subject to omitted variables

bias.15

[Insert Table 5]

4.3.2.2. Self-selection bias (Heckman selection model)

As mentioned earlier, the Code is not mandatory but rather provides provisions for good

governance, leaving the company the flexibility to comply or explain why it does not comply with

it. Since complying with the Code is voluntary, it is possible that our sample is systematically biased.

Thus, we employ Heckman’s (1979) two-step estimation method to correct for self-selection bias

resulting from the fact that compliance with the Code is a managerial decision rather than a random

choice. In the first-stage model, we run probit regression of the likelihood of the choice to have

good governance, that complies with the Code recommendations, on accounting, market, and

macroeconomic variables, as well as the tone in managerial disclosures (i.e., those composing the

benchmark variables). The first-stage model also includes our two exogenous instruments

mentioned in the previous test as suggested by Larcker and Rusticus (2010).

Consistent with DeFond et al. (2005), and following the Code recommendations, the

conventional CG variables employed in our study are utilized to construct an indicator of good

governance, CG_good. Specifically, CG_good is a dummy variable that takes the value of 1 if the

firm’s CG summary is greater than the sample median and 0 otherwise. In this respect, we construct

a CG summary measure that is equal to the sum of the study’s five conventional CG variables (i.e.,

a scale ranging from 0 for lowest to 5 for highest). Each conventional CG continuous variable is

turned into a dichotomous variable that takes the value of 1 if it is greater than the sample median

14 Interestingly, gender diversity shows a positive and significant sign in our IV probit regressions that predict CF in the
penultimate year (at the 1% significance level). Thus, board gender diversity does not seem a helpful mechanism to
protect a firm from CF. Although this is, again, against our hypothesis, it accords with literature that suggests that
diversity can lead to more conflicts and reduced group cohesion and inability to reach consensus on riskier policies (so
inefficiently low risk-taking), thereby inefficiently lengthening the decision-making process, particularly when firms need
to react quickly to their risks (e.g., Sila et al., 2016; Bernile et al., 2018).
15 Additionally, following the one-step approach implemented by Ashbaugh-Shaife et al. (2006; refer to their paper for

more details) to address possible endogeneity, we expand our dynamic logit models by including the industry-adjusted
stock returns as a past performance control function. The untabulated results remain qualitatively the same as those
previously reported (gender diversity shows a statistically insignificant positive sign) implying that correlated omitted
variables do not drive our inferences.
25
and 0 otherwise. In the second step, IMR estimated from the probit model in the first step is included

as an additional variable in our analyses of CG-Cf relation. Results reported by Table 6, using

Heckman’s two-step self-selection correction model, are qualitatively similar to those reported under

the main analysis, suggesting that our findings are not subject to self-selection bias. Notably,

observing (in)significant IMR in (one) two years prior to CF tests suggests that self-selction does

(not) affect managerial choice to comply or not with the governance recommendations. Thus,

managerial choice to comply or not with the governance recommendations is unlikely to help when

CF approaches, which further supports our inference that CG practices are less likely to efficiently

intervene to save firms on the brink of failure.

[Insert Table 6]

4.3.3. Dividend policy and CF

Baldwin and Scott (1983) argue that when a firm becomes financially distressed because of

inability to meet its financial liabilities, violations of debt covenants parallel with dividends

cancellation or discount are the first signals of that financial distress. Investigating the link between

dividend policy and financial distress for a sample of troubled NYSE firms, DeAngelo and

DeAngelo (1990) find almost all the managers of sample firms respond to financial distress by early,

multiple and aggressive dividend reductions (exceeding 70%), besides occasional dividend omission.

Therefore, a strong negative association between dividend payouts and the likelihood of CF is

expected. Simultaneously, dividend policy is not exogenous because of its sensitivity to CG factors

(for details see Baker et al., 2011). Thus, we validate our results’ stability by investigating whether

the Dividend_Policy variable (the log of the ratio of the dividend payout per share) subsumes the

significance offered by Exec_Comp, Manag_Net, Social_Net, or Nom_Ind. As expected, Models

1-4 of Table 7 indiate that failure is strongly less likely for firms with higher dividend payouts (Z-

statistic up to -6.432 at the 1% significance level). Nevertheless, in a salient manner implying their

consistency, Exec_Comp, Manag_Net, Social_Net, and Nom_Ind retain their significance in

affecting the probability of CF.

26
 [Insert Table 7]

4.3.4. Financial crisis

Recent research (e.g., Bouslah et al., 2018) suggests the impact of financial crisis on firm’s

total, systematic, and unsystematic risks. To account for any possible effect that the financial crisis

in 2007-2008 would have on our results, we define three distinct periods of our sample: before the

crisis (years 2000-2006), during the crisis (2007-2008), and after the crisis (2009-2016). For these

periods, we employ dummy indicators for the period during and the period after the crisis relative

to the period before the crisis. Models 1-4 of Table 8 indicate that our earlier findings individually

and collectively remain strongly consistent. In addition, relative to the period before the crisis, results

suggest that the probability of CF is intrinsically enlarged both during and after the crisis. This comes

in line with the insolvency records for the UK’s companies released by the UK Insolvency Service

and Companies House (https://www.gov.uk/).

[Insert Table 8]

4.3.5. Alternative estimations and further considerations (multinomial logit model)

We use a multinomial logit model to clarify the association between CG attributes and CF

while recognizing financial distress and bankruptcy risks separately. Our dependent variable has

three different categories, namely, bankrupt firms, financially distressed firms and healthy firms.

These three categories are considered as alternatives without implicit order. Accordingly, a

multinomial logit model is employed and healthy firms are chosen as a reference group (bankrupt

firms vs healthy firms; financially distressed firms vs healthy firms).

Table 9 vividly illustrates the systematic influence of CG factors for either financial distress or

bankruptcy tests. For example, Nom_Ind shows a significantly positive sign on the probability of

financial distress at the 1% significance level, suggesting that the financial decline starts from the

inefficient monitoring role of the nomination committee. Besides, the statistically negative (positive)

sign of Social_Net (Manag_Net and Exec_Comp) shows the importance of these variables to make

a firm less (more) predisposed to go bankrupt, at the 1%, 1%, and 5% significance levels,

27
respectively. Diversity, Aud_Ind, and Rem_Ind show statistically insignificant effect for all tests of

financial distress and bankruptcy. Collectively, the qualitatively systematic inferences provided by

Table 9 are consistent with our previous results. This also demonstrates the power and practicality

of the CF definition that includes the financial distress and bankruptcy risks (Campbell et al. 2008;

Tinoco & Wilson 2013).

[Insert Table 9]

Above, we use a multinomial logit model because the categories of our dependent variable

convey no natural ordering. In unreported tests, however, we assume that our dependent variable

conveys ordinal categories (bankruptcy, financial distress, or healthy) hypothetically like that, for

instance, of a firm’s credit ratings (say: in default, speculative, or investment) (e.g., Ashbaugh-Skaife

et al., 2006). Accordingly, we estimate an ordered logit model predicting the relations between CG

attributes and the possibility of failure. The unreported results are collectively consistent with that

previously drawn from our prior analyses. In addition, controlling for unobserved heterogeneity, the

unreported results of our principal analyses with year and industry fixed effects collectively and

generally are consistent. Overall, our sensitivity tests illustrate that our inferences are robust to using

alternative measures and estimation procedures.

5. Conclusion
In the midst of major corporate collapses and the UK’s oncern to improve the CG system,

this paper explores how executive compensation, board network, gender diversity and oversight

committees are associated with the likelihood of CF. We also explore the efficiency of CG attributes

when CF approaches, to see the ability of governance to intervene in preventing or altering the

course of failure.

We find that CF is less likely when a firm is characterized by a larger size of the board’s social

network, smaller degree of the board’s managerial network, lower executive compensation, and a

non-independent nomination committee. The evidence we find suggests that board gender diversity

and independence of oversight committees are less likely to reduce the likelihood of CF, casting
28
doubt on their effectiveness as monitoring functions. The results also suggest that the explanatory

power of CG indicators is significant but relatively lowered (by about half) as the time to CF

decreases. This implies that despite the capability of CG indicators to render early warning alerts of

CF, CG practices are less likely to efficiently intervene to save firms on the brink of failure.

Additionally, consistent with prior research in the UK (e.g., Short & Keasey, 1999; Hsu & Wu, 2014),

results suggest that the US’s CG findings would probably not be feasible relative to the UK.

Collectively, the empirical evidence provided in this paper should be of interest to the FRC

and the UK Parliament, since it shows practical implications of the UK’s CG Code and other

governance regulations, where executive compensation, oversight committees, and board network

and gender diversity have been put at the core of the CG reform package to address the public

concern. Given the recent periods of great uncertainty and tumult, it is thoughtful to consider our

empirical evidence particularly useful to help in rethinking the implications of CG practices amid

the sudden and unprecedented level of CF due to the Brexit and Covid-19 pandemic (e.g., Ding et

al., 2021). Our study is further timely to provide evidence-based insights to major recent structural

reforms (Kingman 2018; Brydon 2019; BEIS Select Committee 2019; CMA 2019) aiming at

proposing remedies to CG problems in the UK.

References
Accountancy Daily. (2020). FRC criticises tick box mentality to Corporate Governance Code.
Available at: https://shar.es/ab5Bnv
Adams, R. B., & Ferreira, D. (2009). Women in the boardroom and their impact on governance and
performance. Journal of Financial Economics, 94, 291-309.
Appiah, K. O., & Chizema, A. (2016). The impact of board quality and nomination committee on
corporate bankruptcy. Advances in Accounting, 35, 75-81.
Arye Bebchuk, L., & Fried, J. M. (2003). Executive compensation as an agency problem. The Journal
of Economic Perspectives, 17(3), 71-92.
Ashbaugh-Skaife, H., Collins, D. W., & LaFond, R. (2006). The effects of corporate governance on
firms’ credit ratings. Journal of Accounting and Economics, 42(1-2), 203-243.
Baker, H. K., Singleton, J. C., & Veit, E. T. (2011). Survey research in corporate finance: bridging
the gap between theory and practice. Oxford University Press.
Baldwin, C. Y., & Mason, S. P. (1983). The resolution of claims in financial distress the case of
Massey Ferguson. The Journal of Finance, 38(2), 505-516.

29
BEIS Select Committee. (2019). The Future of Audit. London, England: House of Commons of the
United Kingdom. Available at:
https://publications.parliament.uk/pa/cm201719/cmselect/cmbeis/1718/1718.pdf.
Bernile, G., Bhagwat, V., & Yonker, S. (2018). Board diversity, firm risk, and corporate policies.
Journal of Financial Economics, 127(3), 588-612.
Bloom, N., Bunn, P., Chen, S., Mizen, P., Smietanka, P., & Thwaites, G. (2019). The impact of Brexit
on UK firms. National Bureau of Economic Research. Available at:
https://www.nber.org/system/files/working_papers/w26218/w26218.pdf.
Bouslah, K., Kryzanowski, L., & M’Zali, B. (2018). Social performance and firm risk: impact of the
financial crisis. Journal of Business Ethics, 149(3), 643-669.
Boyd, B. K., Haynes, K. T., & Zona, F. (2011). Dimensions of CEO–board relations. Journal of
Management Studies, 48(8), 1892-1923.
Brick, I. E., Palmon, O., & Wald, J. K. (2006). CEO compensation, director compensation, and firm
performance: Evidence of cronyism?. Journal of Corporate Finance, 12(3), 403-423.
Brookes, S. (2018). Would the new corporate governance code have saved Carillion?. Gateley PLC.
Available at: https://gateleyplc.com/insight/quick-reads/would-the-new-corporate-
governance-code-have-saved-carillion/
Brydon, D. (2019). Report of the independent review into the quality and effectiveness of audit.
Available at:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_
data/file/852960/brydon-review-final-report.pdf.
Cadbury Report. 1992. Report of the Committee on the Financial Aspects of Corporate
Governance. London: Committee on the Financial Aspects of Corporate Governance.
Campbell, J. Y., Hilscher, J., & Szilagyi, J. (2008). In search of distress risk. The Journal of
Finance, 63(6), 2899-2939.
Carcello, J. V., & Neal, T. L. (2000). Audit committee composition and auditor reporting. The
Accounting Review, 75(4), 453-467.
Carter, D. A., Simkins, B. J., & Simpson, W. G. (2003). Corporate governance, board diversity, and
firm value. Financial Review, 38(1), 33-53.
Charitou, A., Neophytou, E., & Charalambous, C. (2004). Predicting corporate failure: empirical
evidence for the UK. European Accounting Review, 13(3), 465-497.
Cohen, J., Krishnamoorthy, G., & Wright, A. M. (2002). Corporate governance and the audit
process. Contemporary Accounting Research, 19(4), 573-594.
Competition and Markets Authority (CMA). (2019). Statutory audit market study. Available at:
https://www.gov.uk/cma-cases/statutory-audit-market-study
Competitions & Markets Authority (CMA). (2019). Statutory audit services market study. London,
England. Available at:
https://assets.publishing.service.gov.uk/media/5d03667d40f0b609ad3158c3/audit_final_rep
ort_02.pdf.
Core, J. E., Holthausen, R. W., & Larcker, D. F. (1999). Corporate governance, chief executive
officer compensation, and firm performance. Journal of Financial Economics, 51(3), 371-406.
Correia, M. M. (2014). Political connections and SEC enforcement. Journal of Accounting and Economics,
57(2-3), 241-262.

30
Crespí-Cladera, R., & Pascual-Fuster, B. (2015). Executive directors’ pay, networks and operating
performance: The influence of ownership structure. Journal of Accounting and Public Policy, 34(2),
175-203.
Cuomo, F., Mallin, C., & Zattoni, A. (2016). Corporate governance codes: A review and research
agenda. Corporate governance: An International Review, 24(3), 222-241.
Daily, C. M., & Dalton, D. R. (1994). Bankruptcy and corporate governance: The impact of board
composition and structure. Academy of Management Journal, 37(6), 1603-1617.
Daily, C. M., & Dalton, D. R. (1995). CEO and director turnover in failing firms: An illusion of
change? Strategic Management Journal, 16, 393-400.
Daily, C. M., Johnson, J. L., & Dalton, D. R. (1999). On the measurements of board composition:
Poor consistency and a serious mismatch of theory and operationalization. Decision
Sciences, 30(1), 83-106.
Daily, C. M., Johnson, J. L., Ellstrand, A. E., & Dalton, D. R. (1998). Compensation committee
composition as a determinant of CEO compensation. Academy of Management Journal, 41(2), 209-
220.
Darrat, A. F., Gray, S., Park, J. C., & Wu, Y. (2016). Corporate Governance and Bankruptcy
Risk. Journal of Accounting, Auditing & Finance, 31(2), 163-202.
Davies, R. B., & Studnicka, Z. (2018). The heterogeneous impact of Brexit: Early indications from
the FTSE. European Economic Review, 110, 1-17.
Davydenko, S. A., & Franks, J. R. (2008). Do bankruptcy codes matter? A study of defaults in
France, Germany, and the UK. The Journal of Finance, 63(2), 565-608.
DeAngelo, H., & DeAngelo, L. (1990). Dividend policy and financial distress: An empirical
investigation of troubled NYSE firms. The Journal of Finance, 45(5), 1415-1431.
Dedman, E. (2016). CEO succession in the UK: An analysis of the effect of censuring the CEO-to-
chair move in the Combined Code on Corporate Governance 2003. The British Accounting
Review, 48(3), 359-378.
DeFond, M. L., Hann, R. N., & Hu, X. (2005). Does the market value financial expertise on audit
committees of boards of directors?. Journal of Accounting Research, 43(2), 153-193.
Ding, W., Levine, R., Lin, C., & Xie, W. (2021). Corporate immunity to the COVID-19 pandemic.
Journal of Financial Economics, 141(2), 802-830.
Doxey, M. M., Lawson, J. G., Lopez, T. J., & Swanquist, Q. T. (2021). Do investors care who did
the audit? Evidence from Form AP. Journal of Accounting Research, 59(5), 1741-1782.
Duffhues, P., & Kabir, R. (2008). Is the pay–performance relationship always positive?: Evidence
from the Netherlands. Journal of Multinational Financial Management, 18(1), 45-60.
Elloumi, F., & Gueyie, J. P. (2001). Financial distress and corporate governance: an empirical
analysis. Corporate Governance: The International Journal of Business in Society, 1(1), 15-23.
Elsayed, M., & Elshandidy, T. (2020). Do narrative-related disclosures predict corporate failure?
Evidence from UK non-financial publicly quoted firms. International Review of Financial Analysis,
71, 101555.
Elshandidy, T., & Neri, L. (2015). Corporate governance, risk disclosure practices, and market
liquidity: comparative evidence from the UK and Italy. Corporate Governance: An International
Review, 23(4), 331-356.
Fauver, L., Hung, M., Li, X., & Taboada, A. G. (2017). Board reforms and firm value: Worldwide
evidence. Journal of Financial Economics, 125(1), 120-142.
31
Fernandes, N. (2008). EC: Board compensation and firm performance: The role of independent
board members. Journal of Multinational Financial Management, 18(1), 30-44.
Fich, E. M., & Slezak, S. L. (2008). Can corporate governance save distressed firms from
bankruptcy? An empirical analysis. Review of Quantitative Finance and Accounting, 30, 225-251.
Field, A. (2013). Discovering statistics using IBM SPSS statistics. Sage.
Financial Reporting Council (FRC). (2018). The UK Corporate Governance Code. London.
Available at: https://www.frc.org.uk/news/july-2018/a-uk-corporate-governance-code-that-is-fit-
for-the
Financial Reporting Council (FRC). (2021). Review of Corporate Governance Reporting. London.
Available at: https://www.frc.org.uk/news/november-2021/uk-corporate-governance-code-
reporting-improves,-b
Financial Times (FT). (2020). UK companies are only ‘paying lip service’ to governance reform.
Available at: https://www.ft.com/content/b0c9684a-320a-11ea-9703-eea0cae3f0de
Financial Times (FT). (2021a). Scaled back UK audit reforms attract investor anger. Available at:
https://www.ft.com/content/8fd10df1-efd6-4261-b8ce-c8f189f3a3ef
Financial Times (FT). (2021b). Covid pandemic masks Brexit impact on UK economy. Available at:
https://www.ft.com/content/fbb70741-34cc-4f54-a66b-a2e4b9445f5b
Financial Times (FT). (2021c). New rules can help to reboot the UK stock market. Available at:
https://www.ft.com/content/b996b71b-eb44-48e1-a092-11838f5f8fe2
Franks, J. R., Nyborg, K. G., & Torous, W. N. (1996). A comparison of US, UK, and German
insolvency codes. Financial Management, 25(3), 86-101.
Franks, J., & Mayer, C. (2002). Corporate governance in the UK: contrasted with the US system1.
In CESifo Forum, 3(3), 13-22.
George, P. (2018). Blog: A Code fit for the future. FRC. Available at:
https://www.frc.org.uk/news/july-2018/a-code-fit-for-the-future
Gillan, S. L. (2006). Recent developments in corporate governance: An overview. Journal of Corporate
Finance, 12(3), 381–402.
Green, C. P., & Homroy, S. (2018). Female directors, board committees and firm performance.
European Economic Review, 102, 19-38.
Gulati, R. (1995). Social structure and alliance formation patterns: A longitudinal
analysis. Administrative Science Quarterly, 40(4), 619-652.
Hassan, T. A., Hollander, S., Van Lent, L., & Tahoun, A. (2019). Firm-level political risk:
Measurement and effects. The Quarterly Journal of Economics, 134(4), 2135-2202.
Hassan, T. A., Hollander, S., Van Lent, L., Schwedeler, M., & Tahoun, A. (2020). Firm-level
exposure to epidemic diseases: Covid-19, SARS, and H1N1. National Bureau of Economic
Research. Available at:
https://www.nber.org/system/files/working_papers/w26971/w26971.pdf.
Hassan, T., Hollander, S., van Lent, L., & Tahoun, A. (2021). The global impact of Brexit
uncertainty. Centre for Economic Policy Research. Available at:
https://repec.cepr.org/repec/cpr/ceprdp/DP14253.pdf.
Hassanein, A., Zalata, A., & Hussainey, K. (2019). Do forward-looking narratives affect investors’
valuation of UK FTSE all-shares firms?. Review of Quantitative Finance and Accounting, 52(2), 493-
519.

32
Heckman, J. J. (1979). Sample selection as a specification error. Econometrica, 47, 153–161.
Hoitash, U., Hoitash, R., & Bedard, J. C. (2009). Corporate governance and internal control over
financial reporting: A comparison of regulatory regimes. The Accounting Review, 84(3), 839-867.
Hsu, H. H., & Wu, C. Y. H. (2014). Board composition, grey directors and corporate failure in the
UK. The British Accounting Review, 46(3), 215-227.
Kim, Y. (2005). Board network characteristics and firm performance in Korea. Corporate Governance:
An International Review, 13(6), 800-808.
Kingman, J. (2018). Independent Review of the Financial Reporting Council. Available at:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_
data/file/767387/frc-independent-review-final-report.pdf.
Kirchmaier, T., & Stathopoulos, K. (2008). From fiction to fact: The impact of CEO social
networks (No. 537). Working Paper, Manchester Business School.
Kyere, M., & Ausloos, M. (2020). Corporate governance and firms financial performance in the
United Kingdom. International Journal of Finance & Economics. DOI: 10.1002/ijfe.1883
Laksmana, I. (2008). Corporate board governance and voluntary disclosure of executive
compensation practices. Contemporary Accounting Research, 25(4), 1147-1182.
Larcker, D. F., & Rusticus, T. O. (2010). On the use of instrumental variables in accounting research.
Journal of Accounting and Economics, 49(3), 186-205.
Larcker, D. F., Richardson, S. A., & Tuna, I. (2007). Corporate governance, accounting outcomes,
and organizational performance. The Accounting Review, 82(4), 963-1008.
Lennox, C. S., Schmidt, J. J., & Thompson, A. (2019). Are Expanded audit reports informative to
investors? Evidence from the U.K. Working Paper, University of Southern California,
University of Texas at Austin, and University of Illinois at Urbana-Champaign.
Mallin, C., Melis, A., & Gaia, S. (2015). The remuneration of independent directors in the UK and
Italy: An empirical analysis based on agency theory. International Business Review, 24(2), 175-186.
Mayew, W. J., Sethuraman, M., & Venkatachalam, M. (2015). MD&A disclosure and the firm’s ability
to continue as a going concern. The Accounting Review, 90(4), 1621-1651.
McCahery, J., Moerland, P., Renneboog, L., & Raaijmakers, T. (Eds.). (2002). Corporate governance
regimes: convergence and diversity. Oxford: Oxford University Press.
Muñoz-Izquierdo, N., Segovia-Vargas, M. J., & Pascual-Ezama, D. (2019). Explaining the causes of
business failure using audit report disclosures. Journal of Business Research, 98, 403-414.
Newey, W. K. (1987). Efficient estimation of limited dependent variable models with endogenous
explanatory variables. Journal of Econometrics, 36(3), 231-250.
Nguyen, T. H. H., Ntim, C. G., & Malagila, J. K. (2020). Women on corporate boards and corporate
financial and non-financial performance: A systematic literature review and future research
agenda. International Review of Financial Analysis, 71, 101554.
Orihara, M., & Eshraghi, A. (2022). Corporate governance compliance and herding. International
Review of Financial Analysis, 102029.
Ozkan, N. (2007). Do corporate governance mechanisms influence CEO compensation? An
empirical investigation of UK companies. Journal of Multinational Financial Management, 17(5),
349-364.
Parker, S., Peters, G. F., & Turetsky, H. F. (2002). Corporate governance and corporate failure: a
survival analysis. Corporate Governance: The International Journal of Business in Society, 2(2), 4-12.

33
Perryman, A. A., Fernando, G. D., & Tripathy, A. (2016). Do gender differences persist? An
examination of gender diversity on firm performance, risk, and executive compensation. Journal
of Business Research, 69(2), 579-586.
Petersen, M. A. (2009). Estimating standard errors in finance panel data sets: Comparing approaches.
Review of Financial Studies, 22(1), 435-480.
Platt, H., & Platt, M. (2012). Corporate board attributes and bankruptcy. Journal of Business Research,
65(8), 1139-1143.
Regulations (2013). The Large and Medium-sized Companies and Groups (Accounts and Reports)
(Amendment). Available at: http://www.legislation.gov.uk/id/uksi/2013/1981
Regulations (2018). Companies (Miscellaneous Reporting) Regulations 2018. Available at:
http://www.legislation.gov.uk/id/uksi/2018/860
Renneboog, L., & Zhao, Y. (2011). Us knows us in the UK: On director networks and CEO
compensation. Journal of Corporate Finance, 17(4), 1132-1157.
Robinson, D., Robinson, M., & Sisneros, C. (2012). Bankruptcy outcomes: Does the board
matter?. Advances in Accounting, 28(2), 270-278.
Scellato, G., & Ughetto, E. (2010). The Basel II reform and the provision of finance for R & D
activities in SMEs: An analysis of a sample of Italian companies. International Small Business
Journal, 28(1), 65-89.
SEC. Securities and Exchange Commission. (1992). Executive compensation disclosure. Release 33-
6962. Washington, DC: SEC.
Senbet, L. W., & Wang, T. Y. (2012). Corporate financial distress and bankruptcy: A survey.
Foundations and Trends® in Finance, 5(4), 243-335.
Short, H., & Keasey, K. (1999). Managerial ownership and the performance of firms: Evidence from
the UK. Journal of Corporate Finance, 5(1), 79-101.
Shumway, T. (2001). Forecasting bankruptcy more accurately: A simple hazard model. Journal of
Business, 74, 101–124.
Sila, V., Gonzalez, A., & Hagendorff, J. (2016). Women on board: Does boardroom gender diversity
affect firm risk?. Journal of Corporate Finance, 36, 26-53.
Telegraph (2018). Number of British businesses going bust hits four-year high. Available at:
https://www.telegraph.co.uk/business/2018/01/26/number-british-businesses-going-bust-
hits-four-year-high/?WT.mc_id=tmg_share_tw
Terjesen, S., Sealy, R., & Singh, V. (2009). Women directors on corporate boards: A review and
research agenda. Corporate Governance: An International Review, 17(3), 320-337.
Tinoco, M. H., & Wilson, N. (2013). Financial distress and bankruptcy prediction among listed
companies using accounting, market and macroeconomic variables. International Review of
Financial Analysis, 30, 394-419.
Toms, S., & Wright, M. (2005). Divergence and convergence within Anglo-American corporate
governance systems: Evidence from the US and UK, 1950–2000. Business History, 47(2), 267-
295.
Tosun, O. K. (2021). Changes in corporate governance: externally dictated vs voluntarily
determined. International Review of Financial Analysis, 73, 101608.
Van Houtven, C. H., & Norton, E. C. (2004). Informal care and health care use of older adults.
Journal of Health Economics, 23(6), 1159-1180.

34
Wilson, N., & Altanlar, A. (2011). Director characteristics, gender balance and insolvency risk: an
empirical study. Working Paper, University of Leeds
Wooldridge, J. M. (2010). Econometric analysis of cross section and panel data. 2 nd ed. Cambridge,
MA: MIT Press.
Zona, F., Gomez-Mejia, L. R., & Withers, M. C. (2015). Board interlocks and firm performance:
Toward a combined agency–resource dependence perspective. Journal of Management, 44(2),
589-618.

35
Tables
Table 1
Descriptive statistics
Variable N Mean S.D. Median Q1 Q3
CG unconventional variables (our set of CG explanatory variables):
Exec_Comp 3941 5.834 1.966 6.227 5.525 6.963
Manag_Net 3941 2.963 1.536 3.465 2.604 3.969
Social_Net 3941 3.619 0.773 3.664 3.045 4.159
Diversity 3941 0.051 0.093 0.000 0.000 0.100
Aud_Ind 3941 0.538 0.499 1.000 0.000 1.000
Rem_Ind 3941 0.476 0.499 0.000 0.000 1.000
Nom_Ind 3941 0.180 0.384 0.000 0.000 0.000
CG conventional variables (a set of CG control variables):
Board_Size 3941 1.834 0.335 1.792 1.609 2.079
Board_Ind 3941 0.347 0.234 0.400 0.167 0.500
Board_Own 3941 2.963 1.536 3.465 2.604 3.969
CEO_Turn 3941 0.103 0.304 0.000 0.000 0.000
Duality 3941 0.285 0.451 0.000 0.000 1.000
Accounting, market, macroeconomic, and qualitative control variables (benchmark variables):
Profitability 3941 -3.812 28.220 4.400 -4.950 9.010
Liquidity 3941 2.458 3.385 1.450 0.990 2.360
Leverage 3941 25.255 31.896 17.940 0.330 39.030
Performance 3941 -0.132 1.212 0.138 -0.021 0.281
Price 3941 4.352 1.797 4.554 3.314 5.587
Market_Cap 3941 6.938 0.559 6.930 6.715 7.173
Ab_Return 3941 0.159 13.505 -0.775 -6.652 5.759
MTB 3941 2.429 4.285 1.560 0.880 2.890
Sigma 3941 0.497 0.247 0.435 0.316 0.626
TBR 3941 2.713 2.174 3.871 0.389 4.746
PRI 3941 213.288 27.711 208.500 188.200 242.000
Neg_Tone 3941 0.934 0.234 0.905 0.761 1.078
This table presents summary statistics for all independent variables over the period 2000 to 2016. The entire sample of 544
firms (3941 firm-year observations) comprises 272 failed firms (1570 firm-year observations) matched with 272 healthy
firms (2371 firm-year observations). Exec_Comp is measured as the log of the executives’ (executive directors) salary plus
bonus. Manag_Net (board’s managerial network ), on the board level, is the log of the number of directors who have direct
links with the firm’s board members. Social_Net (board’s social network), on the firm aggregated level, is the log of the
number of overlaps through employment, education and other activities for the board of directors. Diversity is the
proportion of female directors on the board of directors. Aud_Ind, Rem_Ind and Nom_Ind outline oversight committees’
independence represented by dummy variables with a value of 1 if the (audit, remuneration, or nomination) committee is
totally composed of independent non-executives, and a value of 0 otherwise. Board_Size = the log of the total number of
board of directors. Board_Ind = the proportion of independent non-executive directors to the board size. Board_Own =
the log of the percentage of shares owned by firm insiders. CEO_Turn = 1 if the firm experienced a change in CEO and
0 otherwise. Duality = 1 if the CEO is also chairperson of the board of directors or executive chairperson is present on the
board and 0 otherwise. Profitability = net income/total assets. Liquidity = current assets/current liabilities. Leverage =

36
total debt/total equity. Performance = total funds from operations/total liabilities. Price = the log of firm’s equity price.
Market_Cap = the firm’s relative value as the log of the firm’s market capitalization relative to the total market capitalization
of the FTSE All Share index. Ab_Return = the firm’s cumulative annual returns minus the FTSE All Share return index
for the same period of time. Sigma = the mean volatility of market returns that used as a measure of total risk. MTB =
market value equity/book value equity. RPI = the Retail Price Index (RPI) in base 100 as a measure of the inflation rate.
TBR = the 3-Treasury Bill Rate as a proxy for interest rates. Neg_Tone = the percentage of negative words in the annual
report narratives; captured by an automated textual analysis using Loughran and McDonald’s negative wordlist
(http://www3.nd.edu/~mcdonald/Word_Lists.html). All continuous variables are winsorized at 1% on both tails.

37
Table 2
Spearman’s rho correlations among dependent, explanatory and control variables
Variable 1 2 3 4 5 6 7 8 9 10 11 12 13
1 CF 1.000
2 Exec_Comp -0.145 1.000
3 Manag_Net -0.111 0.540 1.000
4 Social_Net -0.111 0.472 0.478 1.000
5 Diversity -0.039 0.177 0.221 0.225 1.000
6 Aud_Ind -0.108 0.434 0.299 0.329 0.157 1.000
7 Rem_Ind -0.098 0.381 0.291 0.303 0.157 0.786 1.000
8 Nom_Ind -0.022 0.182 0.197 0.175 0.134 0.403 0.443 1.000
9 Board_Size -0.151 0.642 0.821 0.527 0.216 0.332 0.293 0.169 1.000
10 Board_Ind -0.109 0.419 0.318 0.443 0.226 0.722 0.660 0.429 0.360 1.000
11 Board_Own 0.052 -0.353 -0.210 -0.312 -0.069 -0.268 -0.252 -0.162 -0.225 -0.309 1.000
12 CEO_Turn 0.094 -0.045 0.134 0.046 0.008 0.005 0.009 0.021 0.011 0.020 -0.010 1.000
13 Duality 0.015 -0.054 -0.081 -0.155 -0.073 -0.092 -0.066 -0.122 -0.100 -0.209 0.138 0.004 1.000
14 Profitability -0.273 0.376 0.197 0.127 0.146 0.233 0.191 0.107 0.268 0.234 -0.100 -0.107 -0.065
15 Liquidity -0.064 -0.137 -0.136 -0.062 -0.051 -0.063 -0.106 -0.069 -0.105 -0.087 0.083 -0.032 -0.023
16 Leverage -0.020 0.269 0.212 0.166 0.064 0.164 0.161 0.099 0.229 0.213 -0.168 0.026 -0.036
17 Performance -0.256 0.304 0.150 0.100 0.116 0.216 0.163 0.060 0.211 0.211 -0.035 -0.078 -0.018
18 Price -0.209 0.523 0.420 0.348 0.163 0.289 0.240 0.158 0.464 0.346 -0.260 -0.028 -0.026
19 Market_Cap -0.115 0.079 0.016 0.015 0.027 0.022 0.015 0.021 0.068 0.017 -0.027 -0.059 0.030
20 Ab_Return -0.045 0.059 0.026 0.037 0.056 0.057 0.052 0.034 0.025 0.052 -0.012 -0.034 -0.027
21 MTB -0.083 0.215 0.167 0.173 0.112 0.120 0.120 0.075 0.205 0.107 -0.128 -0.041 -0.084
22 Sigma 0.209 -0.404 -0.308 -0.218 -0.181 -0.238 -0.174 -0.092 -0.365 -0.266 0.141 0.076 0.088
23 TBR 0.047 -0.088 -0.024 -0.165 -0.197 -0.071 -0.044 -0.096 0.018 -0.136 -0.014 0.005 0.078

38
24 PRI 0.053 0.049 -0.009 0.170 0.225 0.075 0.024 0.112 -0.072 0.137 0.062 0.021 -0.114
25 Neg_Tone 0.262 -0.336 -0.217 -0.123 -0.047 -0.197 -0.172 -0.045 -0.293 -0.146 0.111 0.113 0.067
14 15 16 17 18 19 20 21 22 23 24 25
14 Profitability 1.000
15 Liquidity 0.055 1.000
16 Leverage 0.048 -0.498 1.000
17 Performance 0.739 0.119 -0.095 1.000
18 Price 0.424 -0.045 0.178 0.357 1.000
19 Market_Cap 0.176 0.045 -0.028 0.141 -0.003 1.000
20 Ab_Return 0.090 0.015 -0.011 0.075 0.005 0.148 1.000
21 MTB 0.221 0.053 0.047 0.144 0.387 -0.172 -0.058 1.000
22 Sigma -0.453 0.010 -0.160 -0.399 -0.520 -0.076 -0.029 -0.212 1.000
23 TBR -0.012 -0.018 0.059 -0.085 0.005 -0.144 -0.129 0.061 -0.018 1.000
24 PRI 0.008 0.045 -0.078 0.054 -0.004 0.016 0.101 -0.036 -0.041 -0.768 1.000
25 Neg_Tone -0.519 -0.109 0.042 -0.470 -0.342 -0.171 -0.066 -0.190 0.359 -0.045 0.091 1.000
This table reports the Spearman’s rho correlations of all dependent, explanatory and control variables. Bold number indicates significance based on two-tailed t-tests, at the 0.05 level or better.
All continuous variables are winsorized at 1% on both tails. Refer to Table 1 for variables details.

39
Table 3
Dynamic logit regression of CF indicator on CG variables
Predicted One year prior to CF Two years prior to CF
sign
Variables Model 1 Model 2 Model 3 Model 4
Exec_Comp + 0.084** 0.088** 0.095** 0.097**
(2.057) (2.029) (2.181) (2.158)
Manag_Net + 0.099 0.114 0.322*** 0.316**
(0.916) (0.845) (2.744) (2.135)
Social_Net – -0.173*** -0.181*** -0.209*** -0.212***
(-2.830) (-2.823) (-3.056) (-2.976)
Diversity – 0.677 0.692 0.681 0.679
(0.839) (0.865) (0.806) (0.792)
Aud_Ind – 0.046 0.009 -0.016 0.023
(0.188) (0.036) (-0.064) (0.087)
Rem_Ind – -0.299 -0.318 -0.246 -0.208
(-1.173) (-1.231) (-0.977) (-0.814)
Nom_Ind – 0.431** 0.403* 0.417** 0.404*
(2.054) (1.930) (2.011) (1.944)
Board_Size – -0.241 -0.016
(-0.590) (-0.039)
Board_Ind – 0.127 -0.274
(0.279) (-0.570)
Board_ Own – -0.068 -0.044
(-1.262) (-0.811)
CEO_Turn + 0.467*** 0.102
(2.828) (0.481)
Duality + -0.089 -0.137
(-0.529) (-0.845)
Profitability – -0.009*** -0.009*** -0.012*** -0.012***
(-4.819) (-4.618) (-5.587) (-5.392)
Liquidity – 0.006 0.009 0.014 0.014
(0.306) (0.474) (0.622) (0.617)
Leverage + 0.004** 0.004** 0.003 0.003
(2.288) (2.320) (1.479) (1.521)
Performance – -0.061 -0.062 -0.040 -0.040
(-1.041) (-1.060) (-0.614) (-0.624)
Price – -0.190*** -0.196*** -0.199*** -0.199***
(-3.983) (-4.052) (-4.155) (-4.138)
Market_Cap – -0.196* -0.194* -0.132 -0.129
(-1.880) (-1.854) (-1.214) (-1.171)

40
Ab_Return – -0.002 -0.002 -0.008 -0.008*
(-0.556) (-0.471) (-1.619) (-1.681)
MTB + 0.001 0.004 0.018 0.018
(0.111) (0.273) (1.413) (1.472)
Sigma + 0.953*** 0.875*** 1.042*** 1.045***
(3.304) (3.008) (3.487) (3.453)
TBR + 0.318*** 0.312*** 0.438*** 0.436***
(5.345) (5.216) (7.788) (7.720)
RPI + 0.028*** 0.027*** 0.036*** 0.036***
(5.959) (5.770) (7.242) (7.075)
Neg_Tone + 2.424*** 2.357*** 2.079*** 2.082***
(7.976) (7.864) (6.437) (6.484)
Constant -9.825*** -8.987*** -12.374*** -12.103***
(-5.589) (-4.936) (-6.991) (-6.668)
Observations 3,941 3,941 3,441 3,441
Pseudo R2 0.207 0.212 0.194 0.195
Pseudo R2 (CG variables) 4% 6.5% 7.2% 7.7%
LRT (p-value) < 0.01a < 0.05b < 0.01a 0.7881b
AUC 0.823 0.824 0.817 0.817
This table reports the results from dynamic logit CF prediction models. Robust standard errors adjusted for clustering at the firm
level. Z-statistics are in parentheses. Significance level: *** p<0.01, ** p<0.05 and * p<0.1. Refer to Table 1 for variable details.
‘Pseudo R2 (CG variables)’ reports the incremental explanatory power of CG variables relative to benchmark variables (i.e.,
accounting, market, macroeconomic and negative tone variables). LRT is the likelihood ratio test statistics for: a Model 1 (3) relative
to a model that contains benchmark variables, and b Model 2 (4) relative to Model 1 (3). Thus, LRT represents the significance of
including the CG unconventional (i.e., CG variables under Models1 and 3) and conventional (i.e., further CG variables under
Models 2 and 4) parameters in the model. The AUC measures the model ability to discriminate between failed and healthy firms
with a higher score suggesting improved predictive ability.

41
Table 4
Dynamic logit regression where oversight committees’ independence is proportions, and gender diversity is a dichotomous variable
Predicted One year prior to CF Two years prior to CF
sign
Variables Model 1 Model 2 Model 3 Model 4
Exec_Comp + 0.074* 0.079* 0.092** 0.095**
(1.760) (1.774) (2.083) (2.044)
Manag_Net + 0.080 0.106 0.311*** 0.326**
(0.742) (0.779) (2.646) (2.182)
Social_Net – -0.187*** -0.188*** -0.215*** -0.220***
(-2.962) (-2.863) (-3.033) (-2.992)
Diversity – 0.057 0.073 0.160 0.163
(0.332) (0.421) (0.861) (0.859)
Aud_Ind – -0.326 -0.257 -0.192 -0.143
(-0.754) (-0.569) (-0.400) (-0.287)
Rem_Ind – -0.030 -0.040 -0.191 -0.194
(-0.071) (-0.082) (-0.385) (-0.358)
Nom_Ind – 0.633** 0.611** 0.424 0.400
(2.151) (2.109) (1.410) (1.331)
Board_Size – -0.302 -0.095
(-0.733) (-0.233)
Board_Ind – -0.113 -0.120
(-0.174) (-0.179)
Board_ Own – -0.061 -0.036
(-1.116) (-0.669)
CEO_Turn + 0.457*** 0.104
(2.784) (0.494)
Duality + -0.096 -0.154
(-0.571) (-0.944)
Constant -9.601*** -8.779*** -12.193*** -11.892***
(-5.357) (-4.739) (-6.778) (-6.428)
Benchmark variables Included Included Included Included
Observations 3,941 3,941 3,441 3,441
Pseudo R2 0.208 0.212 0.194 0.195
Pseudo R2 (CG variables) 4.5% 6.5% 7.2% 7.7%
LRT (p-value) < 0.01a < 0.05b < 0.01a 0.8070b
AUC 0.822 0.823 0.817 0.817
This table reports the results from dynamic logit CF prediction models while employing the independence of oversight committees
as the proportion of independent non-executives over the size of each committee. Audit_Ind is the proportion of independent non-
executives in the audit committee, Rem_Ind is the proportion of independent non-executives in the remuneration committee and
Nom_Ind is the proportion of independent non-executives in the nomination committee. We also employ Diversity as a
dichotomous variable takes 1 if a female director is present on the board and 0 otherwise. Benchmark variables indicate the inclusion
of accounting, market, macroeconomic and negative tone control variables. Robust standard errors adjusted for clustering at the firm
level. Z-statistics are in parentheses. ‘Pseudo R2 (CG variables)’ reports the incremental explanatory power of CG variables relative

42
to benchmark variables (i.e., accounting, market, macroeconomic and negative tone variables). LRT is the likelihood ratio test
statistics for: a Model 1 (3) relative to a model that contains benchmark variables, and b Model 2 (4) relative to Model 1 (3). Thus,
LRT represents the significance of including the CG unconventional (i.e., CG variables under Models1 and 3) and conventional (i.e.,
further CG variables under Models 2 and 4) parameters in the model. The AUC measures the model ability to discriminate between
failed and healthy firms with a higher score suggesting improved predictive ability. Significance level: *** p<0.01, ** p<0.05 and *
p<0.1. Refer to Table 1 for variable details.

43
Table 5
Endogeneity test: IV probit regression of CF indicator on CG variables
Predicted One year prior to CF Two years prior to CF
sign
Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
IV IV IV(a) IV(a) IV IV IV(a) IV(a)
Exec_Comp + 0.034 0.046 0.034 0.046 0.073** 0.079** 0.072** 0.079**
(1.166) (1.525) (1.177) (1.545) (2.350) (2.496) (2.326) (2.483)
Manag_Net + 0.161* 0.494*** 0.152* 0.470*** 0.176* 0.308 0.166* 0.280
(1.865) (2.777) (1.751) (2.650) (1.879) (1.561) (1.759) (1.420)
Social_Net – -0.113*** -0.085** -0.114*** -0.085** -0.104** -0.099** -0.103** -0.097**
(-2.836) (-2.077) (-2.833) (-2.073) (-2.395) (-2.244) (-2.358) (-2.202)
Diversity – 0.612 0.652 0.588 0.631 1.377*** 1.371*** 1.360*** 1.357***
(1.387) (1.469) (1.330) (1.422) (2.991) (2.979) (2.946) (2.943)
Aud_Ind – 0.183 0.463 0.054 0.337 -0.406 -0.381 -0.520 -0.486
(0.411) (0.968) (0.121) (0.710) (-0.860) (-0.766) (-1.109) (-0.984)
Rem_Ind – -0.416 -0.471 -0.289 -0.347 0.194 0.144 0.312 0.263
(-0.920) (-0.955) (-0.646) (-0.711) (0.405) (0.274) (0.657) (0.506)
Nom_Ind – 0.416* 0.412 0.425* 0.410 0.005 -0.036 0.015 -0.038
(1.688) (1.576) (1.725) (1.568) (0.017) (-0.126) (0.055) (-0.132)
Board_Size – -1.035*** -0.991*** -0.354 -0.305
(-3.309) (-3.179) (-1.024) (-0.885)
Board_Ind – -0.533 -0.530 0.065 0.047
(-0.889) (-0.893) (0.102) (0.076)
Board_ Own – -0.024 -0.023 -0.005 -0.004
(-0.948) (-0.891) (-0.165) (-0.152)
CEO_Turn + 0.055 0.062 -0.057 -0.048
(0.485) (0.547) (-0.441) (-0.371)
Duality + -0.052 -0.049 -0.065 -0.065
(-0.647) (-0.610) (-0.764) (-0.760)
Profitability – -0.006*** -0.005*** -0.006*** -0.005*** -0.007*** -0.006*** -0.007*** -0.006***
(-4.813) (-4.269) (-4.802) (-4.266) (-4.516) (-4.246) (-4.488) (-4.234)
Liquidity – 0.010 0.012 0.010 0.012 0.003 0.004 0.004 0.004
(0.824) (0.978) (0.846) (0.982) (0.255) (0.269) (0.268) (0.266)
Leverage + 0.002* 0.002** 0.002* 0.002** 0.002 0.002* 0.002 0.002*
(1.823) (2.114) (1.824) (2.118) (1.583) (1.682) (1.612) (1.706)
Performance – -0.051 -0.049 -0.050 -0.049 -0.043 -0.044 -0.044 -0.044
(-1.482) (-1.415) (-1.473) (-1.421) (-1.068) (-1.067) (-1.083) (-1.082)
Price – -0.113*** -0.102*** -0.111*** -0.100*** -0.083*** -0.081*** -0.081*** -0.080***
(-5.082) (-4.435) (-4.989) (-4.356) (-3.378) (-3.239) (-3.330) (-3.190)
Market_Cap – -0.116* -0.081 -0.115* -0.082 -0.051 -0.035 -0.050 -0.037

44
 (-1.954) (-1.347) (-1.935) (-1.352) (-0.784) (-0.534) (-0.778) (-0.552)
Ab_Return – -0.003 -0.003 -0.003 -0.003 -0.004 -0.004 -0.004 -0.004
(-1.128) (-1.346) (-1.125) (-1.327) (-1.517) (-1.633) (-1.529) (-1.629)
MTB + 0.004 0.005 0.003 0.005 0.009 0.010 0.009 0.010
(0.473) (0.727) (0.465) (0.712) (1.042) (1.189) (1.045) (1.176)
Sigma + 0.639*** 0.608*** 0.626*** 0.594*** 0.747*** 0.757*** 0.739*** 0.750***
(3.930) (3.674) (3.847) (3.591) (4.170) (4.172) (4.114) (4.123)
TBR + 0.165*** 0.164*** 0.164*** 0.164*** 0.225*** 0.226*** 0.224*** 0.226***
(5.542) (5.470) (5.515) (5.451) (6.891) (6.925) (6.870) (6.910)
RPI + 0.014*** 0.013*** 0.014*** 0.013*** 0.017*** 0.017*** 0.017*** 0.017***
(5.428) (5.039) (5.415) (5.049) (6.055) (5.883) (6.039) (5.898)
Neg_Tone + 1.233*** 1.208*** 1.223*** 1.200*** 1.112*** 1.104*** 1.105*** 1.099***
(7.285) (6.890) (7.234) (6.857) (5.979) (5.811) (5.941) (5.784)
Constant -5.223*** -4.805*** -5.177*** -4.795*** -6.784*** -6.688*** -6.747*** -6.684***
(-5.565) (-5.060) (-5.519) (-5.053) (-6.531) (-6.418) (-6.492) (-6.412)
Observations 3,280 3,280 3,280 3,280 2,755 2,755 2,755 2,755
Cragg-Donald F 175.548 92.902 136.894 73.072 146.959 75.136 114.421 59.213
statistic
C (GMM <0.01 <0.01 <0.01 <0.01 0.063 0.059 0.060 0.061
distance) test (p-
value)
Wald test of <0.01 <0.01 0.011 0.013 0.055 0.051 0.043 0.041
endogeneity (p-
value)
Test 0.285 0.316 0.3721 0.392
overidentifying
restrictions (p-
value)
This table reports the results from instrumental variables (IV) probit CF prediction models that address possible endogeneity. Models 1, 2,
5, and 6 use the lagged values of the unconventional CG variables as instrumental variables. In Models 3, 4, 7, and 8, two additional
instruments are used: the standard deviation of the number of qualifications of all firms’ directors over the same period, and the standard
deviation of the time on board values of all firms’ directors over the same period. Z-statistics are in parentheses. Significance level: ***
p<0.01, ** p<0.05 and * p<0.1. Refer to Table 1 for variable details.

45
Table 6
Endogeneity test: Dynamic logit regression of CF indicator on CG variables after controlling for self-selection bias
Predicted One year prior to CF Two years prior to CF
Variables sign
Model 1 Model 2 Model 3 Model 4
Exec_Comp + 0.079* 0.084* 0.099** 0.101**
(1.904) (1.916) (2.193) (2.183)
Manag_Net + 0.081 0.124 0.332*** 0.359**
(0.740) (0.905) (2.759) (2.378)
Social_Net – -0.181*** -0.189*** -0.230*** -0.233***
(-2.892) (-2.886) (-3.268) (-3.205)
Diversity – 0.668 0.692 0.680 0.683
(0.813) (0.854) (0.781) (0.780)
Aud_Ind – 0.108 0.058 0.046 0.064
(0.433) (0.217) (0.190) (0.241)
Rem_Ind – -0.353 -0.393 -0.318 -0.300
(-1.374) (-1.513) (-1.273) (-1.189)
Nom_Ind – 0.426** 0.389* 0.418** 0.404*
(2.038) (1.869) (2.014) (1.943)
Board_Size – -0.364 -0.133
(-0.895) (-0.334)
Board_Ind – 0.251 -0.147
(0.545) (-0.306)
Board_ Own – -0.069 -0.049
(-1.302) (-0.916)
CEO_Turn + 0.475*** 0.080
(2.874) (0.376)
Duality + -0.076 -0.101
(-0.450) (-0.612)
Profitability – -0.013*** -0.012*** -0.019*** -0.019***
(-3.569) (-3.475) (-5.129) (-4.899)
Liquidity – 0.009 0.013 0.018 0.018
(0.448) (0.652) (0.788) (0.796)
Leverage + 0.002 0.002 0.000 0.000
(1.142) (1.103) (0.080) (0.120)
Performance – -0.035 -0.034 -0.006 -0.007
(-0.575) (-0.558) (-0.087) (-0.103)
Price – -0.281*** -0.294*** -0.405*** -0.407***
(-3.005) (-3.141) (-4.335) (-4.225)
Market_Cap – -0.178 -0.174 -0.079 -0.076
(-1.644) (-1.610) (-0.727) (-0.687)
Ab_Return – -0.002 -0.002 -0.006 -0.006
(-0.495) (-0.427) (-1.121) (-1.181)
MTB + 0.003 0.006 0.023* 0.024*
(0.224) (0.429) (1.720) (1.825)
Sigma + 1.385*** 1.338*** 1.876*** 1.878***
(3.236) (3.118) (4.401) (4.311)

46
TBR + 0.355*** 0.352*** 0.516*** 0.516***
(5.236) (5.185) (7.885) (7.755)
RPI + 0.027*** 0.026*** 0.034*** 0.034***
(5.561) (5.385) (6.681) (6.589)
Neg_Tone + 2.557*** 2.493*** 2.269*** 2.260***
(7.787) (7.659) (6.647) (6.636)
IMR ? -0.906 -0.970 -1.846** -1.844**
(-1.230) (-1.332) (-2.522) (-2.455)
Constant -8.598*** -7.592*** -10.019*** -9.684***
(-4.196) (-3.688) (-4.892) (-4.681)
Observations 3,826 3,826 3,328 3,328
Pseudo R2 0.206 0.212 0.197 0.198
This table reports the results from dynamic logit CF prediction models after controlling for self-selection bias using inverse Mill’s
ratio (IMR) estimated by Heckman’s two-stage method. Robust standard errors adjusted for clustering at the firm level. Z-statistics
are in parentheses. Significance level: *** p<0.01, ** p<0.05 and * p<0.1. Refer to Table 1 for variable details.

47
Table 7
Dynamic logit regression of CF indicator on CG variables while considering dividend policy
Predicted One year prior to CF Two years prior to CF
sign
Variables Model 1 Model 2 Model 3 Model 4
Dividend_Policy – -0.326*** -0.346*** -0.385*** -0.404***
(-5.826) (-5.954) (-6.403) (-6.432)
Exec_Comp + 0.099** 0.097** 0.118** 0.113**
(2.374) (2.250) (2.557) (2.419)
Manag_Net + 0.104 0.112 0.337*** 0.317**
(0.999) (0.876) (2.970) (2.270)
Social_Net – -0.171*** -0.193*** -0.211*** -0.233***
(-2.836) (-3.049) (-3.058) (-3.214)
Diversity – 0.862 0.912 0.828 0.823
(1.092) (1.178) (1.001) (0.987)
Aud_Ind – 0.094 0.017 0.065 0.052
(0.385) (0.067) (0.261) (0.197)
Rem_Ind – -0.274 -0.315 -0.227 -0.200
(-1.065) (-1.224) (-0.867) (-0.766)
Nom_Ind – 0.412** 0.379* 0.374* 0.353*
(1.985) (1.822) (1.778) (1.662)
Board_Size – -0.176 0.091
(-0.455) (0.240)
Board_Ind – 0.285 -0.109
(0.658) (-0.238)
Board_ Own – -0.119** -0.102*
(-2.290) (-1.928)
CEO_Turn + 0.415** 0.038
(2.488) (0.177)
Duality + -0.089 -0.134
(-0.557) (-0.870)
Constant -9.084*** -8.074*** -11.456*** -10.993***
(-5.187) (-4.449) (-6.490) (-6.054)
Benchmark variables Included Included Included Included
Observations 3,941 3,941 3,441 3,441
Pseudo R2 0.223 0.229 0.220 0.222
This table reports the results from dynamic logit CF prediction models considering the dividend policy effects.
Dividend_Policy is measured by the log of the ratio of the dividend payout per share. Benchmark variables indicate
the inclusion of accounting, market, macroeconomic and negative tone control variables. Robust standard errors
adjusted for clustering at the firm level. Z-statistics are in parentheses. Significance level: *** p<0.01, ** p<0.05 and *
p<0.1. Refer to Table 1 for variable details.

48
Table 8
Dynamic logit regression of CF indicator on CG variables with the financial crisis effects
Predicted One year prior to CF Two years prior to CF
sign
Variables Model 1 Model 2 Model 3 Model 4
Crisis ? 0.941*** 0.942*** 0.825*** 0.816***
(3.983) (3.965) (3.050) (3.001)
Post_Crisis ? 1.270*** 1.295*** 0.776** 0.771**
(3.988) (4.044) (2.096) (2.066)
Exec_Comp + 0.097** 0.100** 0.101** 0.101**
(2.385) (2.358) (2.326) (2.277)
Manag_Net + 0.112 0.127 0.325*** 0.318**
(1.036) (0.940) (2.770) (2.126)
Social_Net – -0.186*** -0.196*** -0.211*** -0.217***
(-2.994) (-3.010) (-3.041) (-3.005)
Diversity – 0.768 0.796 0.712 0.701
(0.935) (0.976) (0.843) (0.821)
Aud_Ind – 0.014 -0.024 -0.025 0.003
(0.056) (-0.089) (-0.100) (0.011)
Rem_Ind – -0.248 -0.267 -0.229 -0.199
(-0.962) (-1.024) (-0.891) (-0.766)
Nom_Ind – 0.396* 0.367* 0.419** 0.407**
(1.911) (1.769) (2.044) (1.974)
Board_Size – -0.244 -0.001
(-0.605) (-0.002)
Board_Ind – 0.128 -0.220
(0.277) (-0.453)
Board_ Own – -0.076 -0.048
(-1.416) (-0.890)
CEO_Turn + 0.473*** 0.084
(2.829) (0.392)
Duality + -0.062 -0.118
(-0.371) (-0.728)
Constant -6.914*** -6.025*** -10.279*** -10.009***
(-3.630) (-3.078) (-4.603) (-4.341)
Benchmark variables Included Included Included Included
Observations 3,941 3,941 3,441 3,441
Pseudo R2 0.216 0.221 0.199 0.200
This table reports the results from dynamic logit CF prediction models, considering the financial crisis effects. Relative to the period
before the crisis, Crisis (Post_Crisis) is a dummy variable takes a value of 1 for years 2007 and 2008 (years 2009 to 2016) and 0 otherwise.
Benchmark variables indicate the inclusion of accounting, market, macroeconomic and negative tone control variables. Robust standard
errors adjusted for clustering at the firm level. Z-statistics are in parentheses. Significance level: *** p<0.01, ** p<0.05 and * p<0.1.
Refer to Table 1 for variable details.

49
Table 9
Multinomial logit regression of financial distress and bankruptcy on CG variables (CF indicator on CG variables)
Predicted One year prior to FD/Bankruptcy (BR) Two years prior to FD/Bankruptcy (BR)
Variables sign Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
FD BR FD BR FD BR FD BR
Exec_Comp + 0.069 0.092** 0.066 0.096** 0.062 0.109** 0.040 0.121**
(1.029) (2.039) (0.927) (2.021) (0.781) (2.364) (0.525) (2.471)
Manag_Net + 0.098 0.103 0.104 0.113 0.148 0.423*** -0.113 0.549***
(0.589) (0.868) (0.525) (0.691) (0.821) (3.177) (-0.471) (3.120)
Social_Net – -0.119 -0.206*** -0.131 -0.218*** -0.126 -0.239*** -0.170 -0.225***
(-1.089) (-3.306) (-1.122) (-3.327) (-1.004) (-3.477) (-1.281) (-3.167)
Diversity – -1.228 1.237 -1.218 1.243 -1.801 1.266 -2.024 1.334
(-0.778) (1.506) (-0.770) (1.534) (-0.958) (1.516) (-1.002) (1.605)
Aud_Ind – -0.288 0.194 -0.382 0.174 0.037 -0.050 0.071 -0.008
(-0.620) (0.686) (-0.802) (0.556) (0.070) (-0.208) (0.126) (-0.031)
Rem_Ind – -0.326 -0.338 -0.394 -0.329 -0.244 -0.269 -0.187 -0.254
(-0.673) (-1.155) (-0.816) (-1.092) (-0.474) (-1.029) (-0.373) (-0.950)
Nom_Ind – 1.118*** 0.144 1.108*** 0.100 0.884*** 0.212 0.888** 0.183
(3.190) (0.592) (3.234) (0.405) (2.675) (0.880) (2.561) (0.747)
Board_Size – -0.113 -0.260 1.032 -0.524
(-0.161) (-0.578) (1.522) (-1.234)
Board_Ind – 0.412 0.002 -0.353 -0.168
(0.593) (0.003) (-0.444) (-0.324)
Board_ Own – -0.050 -0.088 -0.074 -0.035
(-0.480) (-1.576) (-0.671) (-0.649)
CEO_Turn + 0.353 0.528*** 0.269 0.041
(1.311) (2.682) (0.706) (0.171)
Duality + 0.020 -0.178 -0.107 -0.145
(0.071) (-1.037) (-0.368) (-0.862)
Profitability – -0.013*** -0.007*** -0.013*** -0.007*** -0.013*** -0.012*** -0.013*** -0.012***
(-5.039) (-3.168) (-4.807) (-2.966) (-5.004) (-4.627) (-5.152) (-4.364)
Liquidity – 0.021 -0.000 0.023 0.004 0.033 0.002 0.035 0.004
(0.765) (-0.015) (0.829) (0.166) (1.079) (0.070) (1.202) (0.134)
Leverage + 0.005 0.004** 0.005 0.004** 0.003 0.002 0.003 0.002
(1.578) (1.975) (1.584) (2.023) (0.992) (0.946) (0.916) (1.017)
Performance – -0.087 -0.024 -0.092 -0.023 -0.091 0.019 -0.088 0.024
(-1.133) (-0.360) (-1.188) (-0.341) (-0.985) (0.269) (-0.975) (0.338)
Price – -0.135* -0.241*** -0.142* -0.247*** -0.044 -0.307*** -0.047 -0.304***
(-1.682) (-5.399) (-1.765) (-5.469) (-0.511) (-6.889) (-0.538) (-6.836)
Market_Cap – -0.191 -0.195 -0.190 -0.194 -0.396** 0.031 -0.408** 0.041

50
 (-1.358) (-1.482) (-1.364) (-1.458) (-2.302) (0.235) (-2.342) (0.309)
Ab_Return – 0.001 -0.005 0.001 -0.005 -0.012 -0.006 -0.011 -0.006
(0.121) (-1.155) (0.185) (-1.081) (-1.586) (-0.959) (-1.484) (-1.087)
MTB + 0.011 -0.008 0.013 -0.006 0.007 0.026 0.005 0.028*
(0.646) (-0.482) (0.728) (-0.374) (0.470) (1.615) (0.313) (1.689)
Sigma + 1.119*** 0.794** 1.067** 0.703** 1.609*** 0.613* 1.672*** 0.617*
(2.740) (2.384) (2.565) (2.081) (3.882) (1.738) (3.901) (1.763)
TBR + -0.003 0.538*** -0.005 0.531*** 0.220** 0.589*** 0.210** 0.593***
(-0.033) (6.520) (-0.056) (6.423) (2.298) (8.755) (2.134) (8.761)
RPI + -0.016** 0.055*** -0.016** 0.054*** -0.002 0.057*** -0.002 0.057***
(-2.430) (8.383) (-2.424) (8.244) (-0.216) (10.169) (-0.172) (9.894)
Neg_Tone + 3.221*** 1.974*** 3.176*** 1.900*** 2.770*** 1.740*** 2.898*** 1.717***
(6.605) (5.729) (6.637) (5.496) (5.025) (4.759) (5.258) (4.699)
Constant -2.433 -15.829*** -1.956 -14.814*** -4.886 -17.970*** -5.182 -17.522***
(-0.997) (-6.631) (-0.762) (-6.066) (-1.625) (-8.712) (-1.638) (-8.350)
Observations 3,941 3,941 3,441 3,441
Pseudo R2 0.214 0.219 0.201 0.204
This table reports the results from multinomial logit FD/Bankruptcy prediction models. Thus, it shows the link between CG variables and
the probability of CF while recognizing financial distress and bankruptcy risks separately. Financial distress (FD) is defined as whenever a firm
simultaneously experiences, for two consecutive years, the following conditions: first, negative growth in the market value; second, its financial
expenses surpass its earnings before interest, taxes, depreciation, and amortization. Bankruptcy (BR) is defined as when a firm’s status is under
administrative receivership, administration, company voluntary arrangement, voluntary liquidation, liquidation or when there is a cancellation
of the firm and it is assumed valueless. Robust standard errors adjusted for clustering at the firm level. Z-statistics are in parentheses.
Significance level: *** p<0.01, ** p<0.05 and * p<0.1. Refer to Table 1 for variable details.

51

View publication stats