Short-Term Debt and Corporate Governance

According to existing theories, short-term creditors promote corporate governance by responding quickly to new information. I show that this very feature of short-term debt can also undermine corporate governance. Though moderate levels of short-term debt improve the efficacy of blockholder exit and increase blockholders’ incentives to engage with the firm, high levels of short-term debt impair governance. In particular, high levels of short-term debt render the threat of exit noncredible, make public engagements too risky, and undermine blockholders’ incentives to engage behind the scenes. I identify a challenge in the governance of firms that rely on short-term funding such as banks.