The influence of corporate governance and institutional environment of countries on the profitability of firms

Abstract

Corporate governance may affect firm performance. However, institutional environment and governance rules of different countries may also influence, at least indirectly, characteristics of companies. In this context, the objective of this investigation is to study the relevance of country-level variables, particularly those related to governance, on firm profitability. Through a two-level regression analysis, we aim to identify (i) how firm-specific variables directly impact performance of companies and (ii) how country-specific variables indirectly affect firm profitability. Using a sample of 17,493 companies from 38 countries, the results suggest that: (i) bureaucracy, corruption and law enforcement of a country are not relevant to firm profitability, (ii) competitiveness in a country has indirect influence on performance, since it influences the sensitivity of firm profitability to financial distress of firms and to the dynamism of sectors in a country, (iii) informational asymmetry linked to lack of disclosure about profits and executive wages influences the sensitivity of profitability to financial distress and (iv) debtholder protection may affect the influence of tangibility on firm profitability, since fixed assets, which are more tangible, serve as collateral to corporate loans.

Key words: institutional environment, corporate governance, firm profitability.