Banker-Directors and CEO Inside Debt

Abstract

Using employment history of over 17,000 directors of non-financial firms, we find that boards with directors who have executive experience in a commercial bank compensate CEOs with higher inside debt. This result is consistent with arguments that professional experience shapes decision-making. The experience effect dominates the potential conflict of interest effect. In line with the experience argument, the result holds for both current and past bank executives and for directors from both banks which are and banks which are not the firm’s creditors. These results are robust to several specifications addressing potential endogeneity. The increase in inside debt associated with banker-directors moves the CEO’s incentives closer to the optimum in which agency costs of outside debt are minimized to benefit shareholders. In line with the monitoring role of bankers, we also find that the link between inside debt and banker-directors is stronger in firms with weaker corporate governance standards.