Some scholars have argued that the use of leverage can improve the efficiency and effectiveness of firms by disciplining managers. In fact, many U.S. corporations significantly increased their use of leverage during the 1980s. However, a number of these highly leveraged corporations have encountered severe performance problems in recent times. The reductions in performance are often attributed to extraordinary debt and, consequently, the value of debt as a disciplining force in the modern corporation is being questioned. Herein, the authors explore inconsistencies in the logic underlying popularly held views regarding the use of debt as a managerial disciplining force. They also highlight investment tradeoffs associated with high debt. Although they do not advocate the elimination of debt, they argue that it must be effectively balanced with other governance mechanisms to ensure maximum firm performance.
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