Ownership Structure and the Cost of Corporate Borrowing

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday November 26, 2010 at 9:08 am
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Editor’s Note: The following post comes to us from Chen Lin, Professor of Finance at the Chinese University of Hong Kong; Yue Ma, Professor of Economics at Lingnan University, Hong Kong; Paul Malatesta, Professor of Finance at the University of Washington; and Yuhai Xuan, Assistant Professor of Business Administration at the Finance Unit of Harvard Business School.

In the paper, Ownership Structure and the Cost of Corporate Borrowing, forthcoming in the Journal of Financial Economics, we study the financial consequences of the divergence between control rights and cash-flow rights in a large sample of companies across 22 East Asian and Western European countries during the period from 1996 to 2008. Specifically, we analyze the effects of control rights-cash-flow rights divergence on firms’ cost of borrowing and provide new insights into the link between the separation of ownership and control and corporate value.

We find consistent evidence that the control rights-cash-flow rights divergence (control-ownership wedge) results in a much higher cost of debt financing (loan spreads). The loan spreads-wedge sensitivity is much higher for family-controlled firms with family-connected CEOs, firms with greater informational opacity, lower credit ratings, and lower propping potentials, and firms during financial crises. We also find a higher loan spreads-wedge sensitivity for bullet loans, loans with longer maturity, and loans without collateral or covenants. On the other hand, the loan spreads-wedge sensitivity is lower for firms in countries with stronger creditor and shareholder protection and more efficient debt enforcement.

Overall, our results shed direct light on the channel through which the divergence between control rights and cash-flow rights affects firm value and highlight the importance of ownership structure in determining the cost of corporate financing.

The full paper is available for download here.

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