Corporate Governance and Debt Selection

Abstract

The amount of debt financing has been larger than the amount of equity financing. Despite the large size of debt issuances, almost all empirical studies of capital structure consider debt to be identical. Corporate governance is the system of rules, practices and processes by which a corporation is directed and controlled. The contractual relationship between management and finance is a substantial aspect of corporate governance. One fundamental element of corporate governance is the role of majority shareholders versus minority. Using data on the debt structure from SEC filings, we examine the relationship between corporate governance and debt selection. We specify debt structure in two ways: bank debt, bonds, program debt, private placements, convertible debt and other debts, and secured, senior unsecured, and subordinated debts. We measure corporate governance by ownership of top owners, blockholders and institutional investors ownership. We predict that strong corporate governance improves accounting information quality and decreases firm risk and default risk. Therefore, a well-built corporate governance will have less bank debts as the usage of bank debts is not essential to monitor the company and reduce information asymmetry. Additionally, since a decrease in default risk and information asymmetry reduces the usage of collateral, the proportion of secured debts, which are collateralized by assets, also becomes smaller.