Does a firm’s management affect its borrowing costs? If research by Yihui Pan, Tracy Yue Wang and Michael S Weisbach is to be believed, the effects are quite substantiated. It has been noted that the greater the uncertainty surrounding the top executives at a firm, the higher the interest rates get. This pattern persists even when there is a change in the management, when the successor is not an heir to the business or when the lender and top management of the firm have no prior relationship. However, although management risk increases the likelihood of default and therefore the promised interest rates on debt, it should not affect expected returns on debt (or equity) or firms’ capital budgeting decisions if investors are well-diversified. This paper proves that managerial policy is an important a factor in lending, as predictability reduces the cost of borrowing.
Title: Does Uncertainty about Management Affect Firms’ Costs of Borrowing?
Source: National Bureau of Economic Research