Credit risk assessment and executives’ legal expertise

Abstract

We study whether firms that are led by chief executive officers (CEOs) with law degrees (lawyer CEOs) have different credit ratings and costs of debt from other firms. Our sample consists of Standard & Poor’s 1500 firms from 1992 to 2020, 9.2% of which have lawyer CEOs. We find that these firms have better credit ratings, compared to other firms. On average, their cost of debt is 10% lower than that of firms led by CEOs without legal backgrounds. Our results are robust to different specifications, sampling methods, and controls, such as firm and CEO characteristics. We identify two ways that CEO expertise translates into higher credit ratings: lawyer CEOs are associated with a lower future volatility of stock returns and a reduction in information risk. The decreased business risk and better financial reporting are associated with 5% lower auditing fees for firms with lawyer CEOs.

CEO Narcissism and Credit Ratings

“…The profitability of the firm is related to the ability of the firm to generate profits that can be used to service and repay debt; we capture the firm's profitability with return on assets (ROA) and a loss indicator regarding whether the firm reported negative earnings and experienced a loss in the fiscal year (LOSS) (Ashbaugh-Skaife et al, 2006;Bhandari & Golden, 2021). Differences in firms' asset structure, as measured by capital intensity (CAPINT) (Bonsall et al, 2017a;Pham et al, 2023), are related to credit risk because firms with greater fixed assets intensity have more resources that can be liquidated to meet debt obligations. We account for differences in firms' debt structures, which are inherently related to default risk, by including an indicator variable (SUBORD) (Ashbaugh-Skaife et al, 2006;Kaplan & Urwitz, 1979) that equals 1 if the firm has subordinated debt and 0 otherwise.…”

“…CEO risk-taking incentives may have an effect on credit risk; in particular, we focus on the sensitivity of managerial wealth to the volatility of firm performance (LNVEGA) and the sensitivity of managerial wealth to firm performance (LNDELTA) (Bonsall et al, 2017a;Kuang & Qin, 2013;Ma et al, 2020). CEO demographic characteristics, such as their tenure and their compensation, can also be related to the risk-taking attitudes of the CEOs; accordingly, we include age (LNAGE), gender (GENDER), tenure (LNTENURE), and total compensation (LNSALARY ) of the CEO (Bhandari & Golden, 2021;Kuang & Qin, 2013;Ma et al, 2020;Pham et al, 2023). Finally, we control for the measure of managerial ability (MASCORE) developed by Demerjian et al (2012) because the literature shows that more able managers could positively affect the firm's credit ratings (Bonsall et al, 2017a;Cornaggia et al, 2017).…”

“…Prior research consistently documents that managerial expertise is a major factor in the process of credit assessment. In particular, prior research has focused on managerial ability (Bonsall et al, 2017a;Cornaggia et al, 2017), CEO general ability (Ma et al, 2020), risk-taking incentives (Kuang & Qin, 2013), political ideology (Bhandari & Golden, 2021;Greiner et al, 2023), and legal expertise (Pham et al, 2023). In line with these findings, Standard & Poor (S&P) (2019) emphasizes in their summary of rating criteria that management-particularly managers' strategic competence-is a key component in determining a firm's credit rating.…”

Alternative finance in bank-firm relationship: how does board structure affect the cost of debt?

“…Thus, H4 connects to Agency Theory by suggesting that board experience, a key aspect of governance, influences a firm's financing costs in the context of alternative finance. Pham et al (2022) argued that while board specialization can bring valuable understanding and expertise, they might also be predisposed to adopt risky financial strategies, possibly leading to increased debt costs in the alternative finance sector. Brandes et al (2016) affirmed this, stating that economicfocused board members might advocate for strategic decisions that are financially profitable but overexposed to risk.…”

“…Younger boards may struggle with the complexities of alternative finance, leading to escalating costs of debt due to perceived risk and uncertainty (Anderson et al, 2004;Brahma et al, 2021). Furthermore, boards specializing in economics may adopt risky financial strategies that inflate the cost of borrowing from alternative finance providers (Brandes et al, 2016;Pham et al, 2022).…”