Does Uncertainty About Management Affect Firms' Costs of Borrowing?

Dice Center Working Paper No. 2014-14

Fisher College of Business Working Paper No. 2014-03-014

52 Pages Posted: 9 Nov 2014 Last revised: 20 Jan 2015

See all articles by Yihui Pan

Yihui Pan

University of Utah - Department of Finance

Tracy Yue Wang

University of Minnesota - Twin Cities - Carlson School of Management

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: November 4, 2014

Abstract

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

Pan, Yihui and Wang, Tracy Yue and Weisbach, Michael S., Does Uncertainty About Management Affect Firms' Costs of Borrowing? (November 4, 2014). Dice Center Working Paper No. 2014-14; Fisher College of Business Working Paper No. 2014-03-014. Available at SSRN: https://ssrn.com/abstract=2520566 or http://dx.doi.org/10.2139/ssrn.2520566

Yihui Pan

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

Tracy Yue Wang

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Michael S. Weisbach (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Register to save articles to
your library

Register

Paper statistics

Downloads
120
rank
227,966
Abstract Views
1,005
PlumX Metrics