Corporate Reputation and Cost of Debt

Abstract:     
Although the theoretical literature starting with Milgrom and Roberts (1982) and Diamond (1989) has recognized that reputation should impact credit relationships, that impact has never been fully quantified. We show that firm reputation – the intangible way in which a company is perceived by others – plays an important role in determining corporate cost of debt. We measure a company’s reputation using the annual ranking of “Most Admired Companies” published by Fortune magazine, which surveys industry experts on perceptions of firm quality along eight attributes. After controlling for credit risk and other known determinants of credit spreads, we find a robust inverse relationship between a firm’s reputation as measured by the Fortune survey and the credit spread on its bonds. We also find this effect to be greater for firms that are subject to greater information asymmetry. By explicitly accounting for an intangible element of credit risk, we substantially improve upon the existing literature which, relying on more tangible factors, concludes that a large component of credit spread variation remains unexplained. We also show that the Fortune reputation measure is a good ex ante predictor of corporate failure, improving upon standard measures used in the literature.

Number of Pages in PDF File: 44

Keywords: Cost of debt, cost of debt capital, cost of capital, borrowing costs, reputation, firm reputation, intangibles, default risk, Fortune magazine reputation survey, Fortune reputation score, bankruptcy, credit spread, bond spread, distress risk, credit rating, pricing of default risk, asymmetric inform

JEL Classification: G11, G12, G13, G14, G32, G33

working papers series