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Corporate governance and the cost of debt: Evidence from director limited liability and indemnification provisions

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  • Bradley, Michael
  • Chen, Dong
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    Abstract

    We find that firms that provide limited liability and indemnification for their directors enjoy higher credit ratings and lower yield spreads. We argue that such provisions insulate corporate directors from the discipline from potential litigation, and allow them to pursue their own interests by adopting low-risk, self-serving operating strategies, which coincidentally redound to the benefit of corporate bondholders. Our evidence further suggests that the reduction in the cost of debt may offset the costs of directorial shirking and suboptimal corporate policies occasioned by this insulation, which may explain why stockholders have little incentive to rescind these legal protections.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 17 (2011)
    Issue (Month): 1 (February)
    Pages: 83-107

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    Handle: RePEc:eee:corfin:v:17:y:2011:i:1:p:83-107

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    Web page: http://www.elsevier.com/locate/jcorpfin

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    Keywords: Limited liability provision Indemnification Corporate governance Cost of debt Risk-taking Board of directors;

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    Cited by:
    1. Lin, Chen & Officer, Micah S. & Wang, Rui & Zou, Hong, 2013. "Directors' and officers' liability insurance and loan spreads," Journal of Financial Economics, Elsevier, vol. 110(1), pages 37-60.
    2. Dong Chen, 2014. "The Non-monotonic Effect of Board Independence on Credit Ratings," Journal of Financial Services Research, Springer, vol. 45(2), pages 145-171, April.
    3. Alves, Paulo & Couto, Eduardo & Francisco, Paulo, 2014. "Board of directors’ composition and financing choices," MPRA Paper 52973, University Library of Munich, Germany, revised 2014.
    4. Boyer, M. Martin & Stern, Léa H., 2012. "Is corporate governance risk valued? Evidence from directors' and officers' insurance," Journal of Corporate Finance, Elsevier, vol. 18(2), pages 349-372.
    5. Andrade, Sandro C. & Bernile, Gennaro & Hood, Frederick M., 2014. "SOX, corporate transparency, and the cost of debt," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 145-165.
    6. Aman, Hiroyuki & Nguyen, Pascal, 2013. "Does good governance matter to debtholders? Evidence from the credit ratings of Japanese firms," Research in International Business and Finance, Elsevier, vol. 29(C), pages 14-34.
    7. Chen, Dong, 2012. "Classified boards, the cost of debt, and firm performance," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3346-3365.
    8. Couwenberg, Oscar & Lubben, Stephen J., 2013. "Solving creditor problems in the twilight zone: Superfluous law and inadequate private solutions," International Review of Law and Economics, Elsevier, vol. 34(C), pages 61-76.

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