Corporate Governance and the Cost of Borrowing

Authors

  • Pascal Frantz,

  • Norvald Instefjord

    Corresponding author
    • Address for correspondence: Norvald Instefjord, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, UK.

      e-mail: ninstef@essex.ac.uk

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    • The first author is at the London School of Economics, London, UK. The second author is at the University of Essex, Colchester, UK. The authors thank the Editor, Norman Strong, and an anonymous referee for insightful and useful comments. (Paper received August, 2011; revised version accepted April, 2013).


Abstract

This paper analyzes the theoretical link between governance (defined loosely as the degree of protection offered to outside shareholders), and the cost of borrowing. We find, consistent with empirical evidence, that improvements in governance reduce the likelihood of default. Also, we find that improvements in governance will monotonically increase or reduce the cost of debt, where the sign of the relationship depends on the firm's restructuring cost in default. Finally, we find that the strength of the governance mechanism can influence the incentives to carry out risk shifting.

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