Does Uncertainty About Management Affect Firms' Costs of Borrowing?
Dice Center Working Paper No. 2014-14
52 Pages Posted: 9 Nov 2014 Last revised: 20 Jan 2015
Date Written: November 4, 2014
Uncertainty about management appears to affect firms’ cost of borrowing and financial policies. In a sample of S&P 1500 firms between 1987 and 2010, CDS spreads, loan spreads and bond yield spreads all decline over the first three years of CEO tenure, holding other macroeconomic, firm, and security level factors constant. This decline occurs regardless of the reason for the prior CEO’s departure. Similar but smaller declines occur following turnovers of CFOs. The spreads are more sensitive to CEO tenure when the prior uncertainty about the CEO’s ability is likely to be higher: when he is not an heir apparent, is an outsider, is younger, and when he does not have a prior relationship with the lender. The spread-tenure sensitivity is also higher when the firm has a higher default risk and when the debt claim is riskier. These patterns are consistent with the view that the decline in spreads in a manager’s first three years of tenure reflects the resolution of uncertainty about management. Firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds in response to these short-term increases in borrowing costs early in their CEOs’ tenure.
Keywords: CEO turnover, CEO tenure, CFO, exogenous turnover, cost of borrowing, loan spread, bond yield spread
JEL Classification: G32, G34, M12, M51
Suggested Citation: Suggested Citation