Corporate Governance and the Cost of Debt: Evidence from Director Limited Liability and Indemnification Provisions

Authors

Michael Bradley, Duke Law SchoolFollow
Dong Chen

Document Type

Article

Publication Date

2011

Keywords

limited liability provision, indemnification, corporate governance, cost of debt, risk taking, directors liability

Abstract

We find that firms that provide limited liability and indemnification for their directors enjoy higher credit ratings and lower yield spreads. We argue that such provisions insulate corporate directors from the discipline from potential litigation, and allow them to pursue their own interests by adopting low-risk, self-serving operating strategies, which coincidentally redound to the benefit of corporate bondholders. Our evidence further suggests that the reduction in the cost of debt may offset the costs of directorial shirking and suboptimal corporate policies occasioned by this insulation, which may explain why stockholders have little incentive to rescind these legal protections.

Comments

This is an article pre-print.

Citation

Michael Bradley & Dong Chen, Corporate Governance and the Cost of Debt: Evidence from Director Limited Liability and Indemnification Provisions, 17 Journal of Corporate Finance 83-107 (2011)