Governance, Takeover Probability, and the Cost of Private Debt

Abstract

Using a sample of bank loans issued to U.S. firms from 2000-2009 we find that specific governance mechanisms determine a firm’s cost of borrowing in syndicated credit agreements. Firms with governance mitigating agency risk between stakeholders, i.e. independent boards, strong shareholder monitoring, and greater CEO pay-performance sensitivity, enjoy lower borrowing costs. Although vulnerability to the market for corporate control is beneficial to shareholders, lenders consider changes in control to be value-reducing and charge higher spreads to firms more likely to be acquired. Lenders reduce the cost of borrowing for firms with governance that reduces the likelihood of an acquisition, especially for borrowers that are financially stronger and at greater risk of takeover. In sum, lenders grant lower spreads to stronger borrowers with staunch anti-takeover provisions and to weaker firms whose governance structures mitigate agency risk. Our study contributes to the literature on the relationship between shareholder and creditor rights, the dynamics of corporate control, and the firm’s cost of capital.

Keywords: corporate governance, private debt, syndicated loans, takeover probability

JEL Classification: G21, G32, G34