Creditor Protection Laws and the Cost of Debt

Abstract

We examine the impact of state payout restrictions on firm credit ratings and bond yields. Using publicly traded bond data for a sample of large firms, we find that firms incorporated in states with more restrictive payout statutes (e.g., New York and California), have better credit ratings and significantly lower yield spreads (about 8.7%) relative to firms incorporated in less restrictive states (e.g., Delaware). These results suggest that incorporation in a more restrictive state provides a credible commitment mechanism for avoiding some of the moral hazard problems associated with long-term debt. This commitment corresponds to an economically and statistically significant difference in market yields and firm financing costs and is robust to controls for ownership, governance, debt type, Delaware versus non-Delaware incorporation, and covenant usage. Overall, our results are consistent with the notion that Delaware incorporation has hidden costs for some firms.

Keywords: state payout restrictions, antitakeover provisions, agency cost, corporate governance

JEL Classification: G32, G34