While corporate governance factors are often thought of as important issues for shareholders, in particular the characteristics and quality of the board of directors, less attention is given to their relevance for creditors. This paper explores the issue by focusing on the impact of board quality on a company’s cost of debt.

The authors hypothesise that a high quality board can reduce the cost of bank loans. Their analysis focuses on loans given to large US public companies between 2003-2005, and shows that during this period companies with larger, more experienced, and more diverse boards were able to achieve lower bank loan costs with fewer restrictive conditions (covenants) imposed. A further unanticipated finding is that companies with a lower proportion of institutional equity ownership appear able to borrow more cheaply than those with higher institutional ownership.

Fields, L.P., Fraser, D.R. and Subrahmanyam, A. (2012) Board quality and the cost of debt capital: the case of bank loans Journal of Banking & Finance, Volume 36:5, p1536–1547


The data sample covered bank loans taken out by around 1500 US companies, excluding financial companies and regulated utilities due to the advantage they enjoy in negotiating loan terms. The primary point of comparison is the interest rate charged, including all associated fees (the ‘all-in’ spread, obtained from a standard industry source, Deal Scan). As a result of the extent of data required, the sample set was tilted towards larger companies with relatively stronger financial profiles than the average company.

Additionally, the authors consider the extent of covenants attached to the loan, a factor that they believe previous research has neglected. Restrictive financial ratio covenants could impede management’s ability to make operational decisions and therefore are an important nonfinancial cost to consider. Since covenants can be tailored to a specific borrower they are infinitely variable. The authors therefore focused on three general categories: if collateral was required, if there were more than two financial ratio restrictions, and if sweeps were required (where the proceeds of any equity, debt, or asset sales are required to be put towards paying off the loan).

The assessment of board quality incorporates a wide range of governance characteristics, including:

  • board size, i.e. the number of directors;
  • director independence;
  • compensation;
  • share ownership;
  • experience (the proportion of directors with more than fifteen years of service);
  • time commitment (the proportion of directors that serve on four or more other boards);
  • diversity (proportion of female directors);
  • advisory capability (the presence of at least one external director who is also employed by another firm in the same industry, or, more external senior directors than average).

Data is sourced from The Corporate Library and the IRRC (Investor Responsibility Research Center) Institute. To avoid problems with ascertaining causality, such as certain types of board directors attracted to companies with better loan rates, the quality measures lag one period relative to the loan, i.e. board quality measures are for the years 2002- 2004.


Overall the key finding was that boards scoring highly on the board quality measures tend to achieve lower loan costs, and in addition are less likely to have restrictive financial ratio covenants imposed. The degree of influences varies between the different factors– board size, independence, experience, and diversity have the biggest influence, with larger boards, more external directors, more experience and more diversity leading to lower loan costs – while there was no evidence for a correlation between loan costs and director commitment, compensation, or insider ownership.

Other notable findings include:

  • A greater advisory presence on the board is correlated with lower loan costs regardless of the degree of board independence overall.
  • The relationship between larger board size and lower loan costs holds regardless of firm size and financial characteristics. In the authors’ view, this may perhaps be due to lenders perceiving large boards as having more combined expertise.
  • Collateral requirements are minimised by greater diversity and more experience on the board, but board quality does not seem to influence the existence of sweep covenants.

These results are robust for companyspecific characteristics such as size, leverage and profitability (in general larger, less leveraged companies with less volatile stock prices and higher returns on assets achieve lower loan costs), as well as various control factors including ownership structure, CEO pay, geographical remoteness of a company, and whether the company has taken a loan in the previous two years.

The authors also find that high CEO pay and a higher proportion of institutional equity ownership appears to increase the cost of borrowing. The reason for this is not clear, but the authors propose two contrasting explanations that would both lead to this outcome: firstly, that institutional owners may be considered more likely to influence management to put shareholder interests before debt holders, or, alternatively, that institutional owners may be thought too passive to help with monitoring and discipline.


Taking both loan cost and covenants into account, high quality boards appear to lead to decreased cost of debt. Fields et al posit this may be due to banks viewing high quality boards as providing additional monitoring, particularly when there is an advisory presence. They highlight that the findings support recent legislation and industry guidelines supporting the recruitment of outside directors to company boards in the US and further afield.

However, firms with higher levels of institutional ownership and greater shareholder protection are at a disadvantage. The authors speculate that this is due to a greater likelihood of takeover which may weaken a company’s ability to repay its debt. This theory would be consistent with other studies that show fewer takeover defences leads to higher borrowing costs.

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    RI Quarterly Vol.1: ESG issues in bank loan pricing and decision making

    October 2013