Corporate Governance and the Cost of Debt: Evidence from Director Limited Liability and Indemnification Provisions

58 Pages Posted: 20 Feb 2010 Last revised: 11 Aug 2014

Michael Bradley

Duke University - Fuqua School of Business

Dong Chen

University of Baltimore

Date Written: August 10, 2014

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.

Keywords: limited liability provision, indemnification, corporate governance, cost of debt, risk taking, board of directors

JEL Classification: G30, G34, K22

Suggested Citation

Bradley, Michael and Chen, Dong, Corporate Governance and the Cost of Debt: Evidence from Director Limited Liability and Indemnification Provisions (August 10, 2014). Journal of Corporate Finance, 2011, vol. 17, issue 1, p83-107. Available at SSRN: https://ssrn.com/abstract=1555303

Michael Bradley

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-8006 (Phone)
919-660-7971 (Fax)

Dong Chen (Contact Author)

University of Baltimore ( email )

1420 N. Charles Street
Baltimore, MD 21201
United States

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