Abstract
This article investigates the link between board members’ past professional experiences and the terms and conditions of the debt contracts of their current firms. In particular, we examine whether directors’ past bankruptcy experience affects the pricing and nonpricing terms of public debt contracts. Using a sample of 8,142 bond issues in the United States in the period 1995 to 2015, we document higher credit spreads and smaller bond sizes for firms with such directors, suggesting that bondholders are concerned about past bankruptcy experience. Our results remain robust to different model specifications. This effect is moderated for bankruptcies that are likely driven by macroeconomic shocks such as the dotcom bubble and the global financial crisis. We also show that our findings are not explained by bond issuers with an elevated risk of default and seem instead to be driven by directors serving on key monitoring committees, indicating that prior bankruptcy experience raises concerns about the company’s corporate governance. Finally, mediation analysis offers some evidence of a limited negative indirect effect of prior bankruptcy experience on the terms of debt contracts through the firm’s financial and investment policies. Overall, our findings suggest that lenders incorporate information about past professional experiences of directors into public debt contracting.
Highlights
The consequences of corporate bankruptcy have received considerable scholarly attention
Several empirical studies suggest that both external (Bhojraj & Sengupta, 2003; Chava et al, 2009; Cremers et al, 2007) and internal (Anderson et al, 2004; Fields et al, 2012; Klock et al, 2005) corporate governance mechanisms are priced in debt contracts. While these studies predominantly focus on the structural characteristics of corporate governance, we investigate the effect of an additional aspect—a director’s prior experience at a distressed firm—an observable characteristic, which has not been previously studied in this context
To the extent that the bondholders are concerned about the quality of the corporate governance of the BE firms after the appointment of a BE director, we expect that the effects of past bankruptcy experience on bond contracts are more pronounced if the BE director serves on a key monitoring committee
Summary
The consequences of corporate bankruptcy have received considerable scholarly attention. The presence of a BE director (Bankruptcy_Exposure = 1) is associated with an average increase in credit spread of 20.4 bps, which is both economically and statistically significant.22 The coefficient of Bankruptcy_Exposure in the estimation of Model (2) is positive and significant (z = 2.54), suggesting that BE issues have higher maturity than non-BE issues, which is Dependent variable Intercept Bankruptcy_Exposure Maturity Bond_Size Credit_Spread Size Lev Profit Tangibility Asset_Specificity Capex Btm Cfo Credit_Rating Not_Rated Speculative_Grade Callable Puttable Sinking_Fund Subordinated Observations R2 Year FE Industry FE
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