Does Board Independence Reduce the Cost of Debt?

Abstract

Using the passage of the Sarbanes-Oxley Act and the associated change in listing standards as a natural experiment, we find that while board independence decreases the cost of debt when credit conditions are strong or leverage low, it increases the cost of debt when credit conditions are poor or leverage high. We also document that independent directors set corporate policies that increase firm risk. These results suggest that, acting in the interest of shareholders, independent directors are increasingly costly to bondholders with the intensification of the agency conflict between these two stakeholders.

Why do large shareholders adopt a short‐term versus a long‐term investment horizon in different firms?

“…One potential way to mitigate the endogeneity issue regarding the relation between board independence and short‐term (long‐term) blockholding investments is to conduct a DID test based on SOX and following SEC rules. Recent studies including Bradley and Chen () and Tosun () exploit the passage of the SOX Act and the associated changes in listing standards as a natural experiment. Following those studies, I use DID regression to identify the causal effect of board independence on short‐term and long‐term blockholding investments.…”