How Management Risk Affects Corporate Debt

Abstract

Management risk occurs when uncertainty about future managerial decisions increases a firm’s overall risk. This paper argues that management risk is an important yet unexplored determinant of a firm’s default risk and the pricing of its debt. CDS spreads, loan spreads and bond yield spreads all increase at the time of CEO turnover, when management risk is highest, and decline over the first three years of CEO tenure, regardless of the reason for the turnover. A similar pattern but of smaller magnitude occurs around CFO turnovers. The increase in the CDS spread at the time of the CEO departure announcement, the change in the spread when the incoming CEO takes office, as well as the sensitivity of the spread to the new CEO’s tenure, all depend on the amount of prior uncertainty about the new management.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.