Default risk and corporate governance in financial vs. non-financial firms

Abstract

This study explores the relation between credit risks of financial and non-financial firms and their corporate governance structures from the perspective of creditors. US based CDS spreads are used to measure firms' risk taking behavior. Governance attributes have differential effects across firm types: Board independence and financial transparency have a greater impact on the default risk of financial firms than on industrial firms. Ownership structure and takeover vulnerability are more important for industrial firms than for financial firms. For industrial firms, CEO ownership has a nonlinear relation with credit risk levels with an inflection point of around 40%, At ownership levels below (above) the inflection point, increased CEO ownership is associated with increased (decreased) credit risk. These results are consistent with an entrenchment effect: at a low level of ownership, the interests of CEOs are more aligned to shareholders than bondholders. For financial firms, CEO ownership is associated with lower default probability only when CEOs hold a large fraction of the firms' shares.