Corporate Governance and the Cost of Borrowing
41 Pages Posted: 6 Mar 2012
Date Written: March 5, 2012
This paper analyzes the theoretical link between governance (defined loosely as the degree of protection offered to outside shareholders), and the cost of borrowing. We find, consistent with empirical evidence, that improvements in governance reduce the likelihood of default. Also, we find that improvements in governance will monotonically increase or reduce the cost of debt, where the sign of the relationship depends on the firm's restructuring cost in default. This finding can also rationalize existing empirical evidence within an optimal contracting argument for the use of debt.
Keywords: benefit diversions, corporate governance, cost of borrowing, default
JEL Classification: G32, G34, G38
Suggested Citation: Suggested Citation