Managerial Opportunism, Cost of Debt Financing and Regulation Changes: Evidence from the Sarbanes-Oxley Act Adoption

Abstract

This paper investigates the impact of managers’ opportunism on the cost of debt financing. Using managerial entrenchment and earnings management activities to proxy for managers’ opportunism, we find that firms with less entrenched managers enjoy lower corporate bond costs and higher credit ratings. In addition, our results suggest that bondholders generally require higher bond costs, while rating agencies assign lower credit ratings to firms that inflate their earnings (i.e. income-increasing earnings management). We further investigate the role of the Sarbanes-Oxley Act adoption on the perceptions of these two debt market actors. We find strong evidence that the dramatic changes required by this Act have enhanced the “monitoring” role of the debt market since we document that the above results are generally observed only for the post-SOX period.