Corporate Boards and Bond Contract Terms

Abstract

I use the NYSE and NASD board independence reforms to examine the relation between board structure and the contract terms of new bond issues. Consistent with the disciplining effect of boards on entrenched managers, I find that firms that transition to independent boards experience reductions in payout, financing, investment, and event risk covenants and attract higher credit ratings on their new bond issues. These contracting benefits are not offset by higher credit spreads. The effects of the reforms are concentrated in low distance-to-default Delaware firms for which state law limits their directors’ incentives to favor equity over debt. The results also suggest that these incentives dominate co-opted directors’ allegiance to the CEO. Following the reforms, bond covenants of high co-option Delaware (non-Delaware) firms decrease (increase). Further analyses reveal that the consequences of the reforms are stronger when firms are more vulnerable to takeovers and have fewer distracted directors. Collectively, these findings suggest that increased oversight of entrenched managers through board independence reforms can reduce bondholders’ agency costs.

Keywords: Bond Covenants, Corporate Boards, Corporate Governance, Cost of Debt, Debt Contracting.

JEL Classification: G30, G32, G38, K22