Do Entrenched Managers Prefer Bonds?

Abstract

Prior research has documented both positive (John and Litov, 2009) and negative (Berger, Ofek, and Yermack, 1997) relationships between managerial entrenchment and the use of debt. This paper further investigates the impact of corporate governance on firm leverage by taking into account the substitution effect of different governance mechanisms. Consistent with John and Litov (2009), we find that antitakeover provisions have a positive effect on firm leverage. However, this effect disappears when we control for the interaction effect between antitakeover provisions and board power, measured by board independence. More specifically, we find that entrenched managers operate highly leveraged firms only if they are exposed to powerful boards. The result of this positive relationship between firm leverage and the interaction of board power and antitakeover provisions continues to hold even after we consider other governance variables.