Does Corporate Governance Matter to Bondholders?

Abstract

We examine the relation between the cost of debt financing and a governance index that contains various antitakeover and shareholder protection provisions. Using firm-level data from the Investors Research Responsibility Center for the period 1990-2000, we find that antitakeover governance provisions lower the cost of debt financing. Segmenting the data into firms with the strongest management rights (strongest antitakeover provisions) and firms with the strongest shareholder rights (weakest antitakeover provisions), we find that strong antitakeover provisions are associated with a lower cost of debt financing while weak antitakeover provisions are associated with a higher cost of debt financing, with a difference of about 34 basis points between the two groups. Overall, the results suggest that antitakeover governance provisions, although not beneficial to stockholders, are viewed favorably in the bond market. also report on antitakeover provisions. For a review on the takeover market, see Agrawal and Jaffe (2003) and for corporate governance see Shleifer and Vishny (1997). 3 We focus on bondholders for several reasons. First, bondholders can provide a balance between shareholders and managers (Jensen (1986)). Second, bonds have shorter durations than equity, and their valuations are well specified and less subject to the criticism that the results might be driven by misspecification of the equilibrium asset pricing model. Third, bonds could be less subject to endogeneity problems because, while a change in governance can cause yields to change immediately, it is less likely that fluctuations in yield will cause governance to change quickly.

Corporate Bond Covenants and Social Responsibility Investment

“…One way to address this issue is to regress the changes in covenants on the changes in CSR and controls. This is similar to Klock et al (2005). Results are reported in Panel A of Table 5.…”

“…15 Thus, we estimate the bond rating without the CSR component, by regressing the bond rating on the CSR variable and labeling the error term from this regression as our primary measure of credit ratings in the multivariate analysis. This method is similar to what Klock et al (2005) do. 16 We also control for a series of firm-specific variables that are likely to be associated with debt contract terms: size, ROA, market-tobook ratio, tangible ratio, and leverage.…”

“…First, as Klock et al (2005) argue, at least one subcategory of CSR, GOV, would be correlated with credit rating. Second, COM (community) might be correlated with the credit rating as well, because not only does COM measure several givings or contributions that would take away some earnings (e.g., 1.5 % of net earnings before tax) of the firm, but also collect information about whether the firm has been involved in major tax disputes involving Federal, state, local or non-U.S. Government authorities.…”

Board Effectiveness and Cost of Debt

“…We provide further evidence on the issue of causation by estimating a two-stage least-squares model (2SLS) (Anderson et al, 2003;Klock et al, 2005). Two-stage procedures rely on instrumental variables to generate predicted values of the independent variables (in our case, the set of governance variables) that are uncorrelated with the error term in the structural model.…”

“…When it comes to studying the relationship between corporate governance and cost of debt, most of the limited, recent previous research is focussed within the framework of the conventional US/UK model of corporate control and deals with the effect of mechanisms such as ownership structure (Anderson et al, 2003;Bhojraj and Sengupta, 2003;Roberts and Yuan, 2006;Zoido, 1998), the exposure to the market for corporate control (Chava et al, 2009;Klock et al, 2005), or both (Cremers et al, 2007) on the cost of borrowing.…”