This study explores the effect of a firm’s corporate governance structure on the cost of its bank loans.

The ability to raise capital is vital for any business and factors that influence the cost of capital could have significant economic impact. The authors hypothesise that banks charge higher loan costs to corporate borrowers with more shareholders rights because such companies tend to have lower takeover defences, and are perceived to be more likely to be acquired with a subsequent increase in risk to the lender. The study focuses on loans taken out by US companies (excluding financial companies) during the period 1990-2004, and finds that companies with more shareholder rights are charged higher interest rates, while those with lower shareholder rights are able to achieve lower loan costs.

Chava, S., Livdan, D. and Purnanandam, A. (2008) Do shareholder rights affect the cost of bank loans? EFA 2004 Maastricht Meetings Paper No. 5061. Available at SSRN: or


The bank loan data is sourced from a standard industry database, Dealscan, and the primary measure of loan cost is the interest rate charged plus additional fees (the ‘all-in’ spread) with most loans being syndicated. Information on shareholder rights and takeover vulnerability is sourced from the Investor Responsibility Research Centre (IRRC), specifically its ‘Corporate Defences Index’, which ranks the strength of shareholders rights across companies based on the number of defensive provisions in its corporate charter, for example, methods to delay hostile takeover bids, protection of company directors, shareholder voting rights, and state laws.


The statistical analysis of loan costs and the takeover vulnerability measure suggests a correlation between increased takeover vulnerability in the variation in interest rates offered to different borrowers, independent of other company characteristics known to influence loan spreads such as company size, leverage and profitability. The difference between the rates charged to the most and least vulnerable companies is of the magnitude of 25% of the loan spread. Furthermore, if a company adds three extra defensive provisions to its corporate charter (one standard deviation from the mean number of provisions), this decreases the loan cost by about 10%, or 12 basis points.

The authors examine a number of factors that interact with takeover vulnerability to affect the loan cost – notably company leverage, syndicate size, and the presence of loan covenants. They find that companies with low leverage are more likely to experience an increase in leverage in the event of a takeover, and correspondingly that companies with more shareholder rights and low leverage are charged the highest loan spreads.

The impact of syndicate size and covenants is more complex. Usually small syndicates are associated with low credit risk as banks typically syndicate higher risk loans across a larger number of participants to diversify their risk exposure. However, within small syndicates the companies with greater takeover vulnerability are charged higher spreads. Similarly, fewer covenants is typically associated with borrowers with lower credit risk. However, the authors find that borrowers with high takeover vulnerability are charged higher loan spreads when they have no collateral or fewer covenants, most likely because a lack of covenants leaves the lender unprotected in the event of a merger.

Chava et al discuss in detail whether the observed relationship between the IRRC takeover vulnerability index and loan spreads is causal, or driven by some other external factor. They believe that banks are indeed pricing the risk of a takeover occurring for several reasons:

  • The average age of companies in the samples is 30 years, and since anti-takeover provisions are typically adopted at the time of IPO and rarely changed it is unlikely that a separate factor is influencing both takeover vulnerability and a loan cost determined 30 years later.
  • Firms with an increase in takeover risk from one year to the next pay significantly more on their loans than firms with a decrease or no change.
  • During periods of high takeover activity the effect of takeover vulnerability on loan costs is seen to be much higher.
  • In states where the legal framework is favourable to corporate takeovers (notably Delaware), companies incorporated here were found to be paying more for their loans despite the companies appearing to have a lower credit risk on average than the national sample.


The authors conclude that after controlling for loan and company specific characteristics, companies with higher takeover risks, as indicated by shareholder-friendly policies, are charged a higher rate for their loans because they believe there is more chance of a takeover that increases the repayment risk. Takeover vulnerability is most significant for companies with better credit profile, low-leverage, and taking out loans with no collateral or covenants or with smaller syndicates.

The reasons for banks’ concern about corporate takeovers are not apparent, and from the results in this study the higher costs charged to more vulnerable companies do not appear to be entirely justified. Although takeovers are likely to come with a period of uncertainty and a possible impact on cash flow and leverage, this study finds no evidence to suggest that firms that appear to be takeover candidates are more likely to default in future (in fact they appear to default less frequently than companies that are less vulnerable to takeovers). Nor is there any evidence to suggest that banks are concerned about companies favouring shareholders with higher dividends, since the takeover/loan spread relationship is as strong in states where shareholder payouts are controlled as in states where they are not. The authors believe that their results have important implications for designing optimal corporate governance structures, since companies relying on the equity market as a corporate governance mechanism are likely to be penalised by higher cost of bank debt, but further research would be needed to investigate the reasons behind this phenomenon.

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

    October 2013