Management Risk and the Cost of Borrowing

Fisher College of Business Working Paper No. 2015-03-13

Charles A. Dice Center Working Paper No. 2015-13

62 Pages Posted: 13 Aug 2015 Last revised: 2 Dec 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 30, 2015

Abstract

Management risk occurs because uncertainty about future managerial decisions increases a firm’s overall risk. This paper documents the importance of management risk in determining firms’ cost of borrowing. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover. Similar but smaller patterns occur around CFO turnovers. The increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management. In response to these short-term increases in borrowing costs early in their CEOs’ tenure, firms adjust their propensities to issue external debt, precautionary cash holding, and reliance on internal funds. All of these results suggest that management risk appears to be an important factor in the pricing of corporate debt.

Keywords: CEO turnover, CEO tenure, CFO, exogenous turnover, cost of borrowing, loan spread, bond yield spread, CDS spread, financial policy

JEL Classification: G32, G34, M12, M51

Suggested Citation

Pan, Yihui and Wang, Tracy Yue and Weisbach, Michael S., Management Risk and the Cost of Borrowing (November 30, 2015). Fisher College of Business Working Paper No. 2015-03-13; Charles A. Dice Center Working Paper No. 2015-13. Available at SSRN: https://ssrn.com/abstract=2641923 or http://dx.doi.org/10.2139/ssrn.2641923

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

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