Stakeholder Orientation and the Cost of Debt: Evidence from State-Level Adoption of Constituency Statutes

Abstract

We examine the causal effect of stakeholder orientation on firms’ cost of debt. Our test exploits the staggered state-level adoption of constituency statutes, which allows directors to consider stakeholders’ interests when making business decisions. We find a significant drop in loan spreads for firms incorporated in states that adopted such statutes relative to firms incorporated elsewhere. We further show that constituency statutes reduce the cost of debt through the channels of mitigating conflicts of interest between residual and fixed claimants and between holders of liquid claims and holders of illiquid claims, limiting legal liability and lowering takeover threats.

For whom (and for when) is the firm governed? The effect of changes in corporate fiduciary duties on tax strategies and earnings management

“…The argument is that laws like constituency statutes permit directors to consider and advance the interests of a wide range of stakeholders, which in turn makes those stakeholders more willing to make firm-specific investments, increasing the value of the company. The research finds that shifts in the fiduciary duty away from shareholder-primacy produces lower borrowing costs and more credit, and attributes their results to precisely this type of mechanism (Becker & Stromberg, 2012;Gao et al, 2016). As Gao et al (2016) write, 'stakeholder orientation as promoted by constituency statutes will lower the cost of debt because it mitigates conflicts of interest between shareholders and other stakeholders regarding firms' investment policies, and thus reduces the agency cost of debt' (p. 9).…”

“…The research finds that shifts in the fiduciary duty away from shareholder-primacy produces lower borrowing costs and more credit, and attributes their results to precisely this type of mechanism (Becker & Stromberg, 2012;Gao et al, 2016). As Gao et al (2016) write, 'stakeholder orientation as promoted by constituency statutes will lower the cost of debt because it mitigates conflicts of interest between shareholders and other stakeholders regarding firms' investment policies, and thus reduces the agency cost of debt' (p. 9).…”

“…There is a competing (and relatively recent) body of research that suggests a stakeholder orientation to corporate law has significant positive effects for debtholders. For example, looking at the impact of constituency statutes on corporate debt, a recent paper finds firms incorporated in states that adopted constituency statutes experience a drop in loan spreads by approximately 15%, for average annual interest savings of $1.15 million (Gao et al, 2016). Firms in constituency statute jurisdictions also increase their leverage, suggesting the change in fiduciary duties make more credit available at lower prices.…”

Do Affiliated Bankers on Board Enhance Corporate Social Responsibility? US Evidence

“…One reason that bankers would be in favor of firms' CSR activities is that such investments reduce firm risk. For example, Gao, Li, and Ma [48] find that adopting stakeholder orientation helps firms mitigate debt overhang and reduce risk of default, myopic behavior, and litigation risk. Banks are known to be the fixed claimants who bear high downside risk, as residual claimants have an incentive to increase the riskiness of a firm's existing assets, even when doing so would reduce firm value [49].…”

Three essays on corporate finance

“…Although we have documented a robust negative relationship between covenant intensity and CSR performance, this association is not immune from endogeneity issues. Moreover, firms with high CSR performance may have lower cost of debt and at the same time enjoy better loan agreements with fewer covenants (e.g., Shi andSun, 2015, Gao, Li andMa, 2020).…”