Consistent with theoretical predictions, we find that both a higher level of financial leverage and a faster speed of adjustment of leverage toward the shareholders’ desired level are associated with better corporate governance quality as defined by a more independent board featuring CEO–chairman separation and greater presence of outside directors, coupled with larger institutional shareholding. In contrast, managerial incentive compensation on average discourages use of debt or adjustments toward the shareholders’ desired level, consistent with its entrenchment effect. The effect of corporate governance on leverage adjustments is most pronounced when initial leverage is between the manager’s desired level and the shareholders’ desired level where the interests of managers and shareholders conflict.