I just finished reading a really terrific empirical study by Joanna Shepherd (Emory Law), Fred Tung (Emory Law), and AlbertYoon (Northwestern Law), entitled Cross-Monitoring and Corporate Governance. In a nutshell, the authors show, after controlling for a wide variety of relevant control variables (most importantly corporate governance), that companies that rely on bank loans, as opposed to equity or public debt, post higher market returns. Presumably, these results flow from the heightened monitoring and positive market signaling supplied by loan agreements. Their multiple specifications do a nice job of ruling out alternative hypotheses.
This is quite an important paper for thinking about manager and director agency costs, especially in a world where portfolio diversification has reduced the incentives for shareholders to pay attention to annual elections for directors. (It also is a excellent example of methodology for large panel data.) Here is the article abstract:
We take the view that corporate governance must involve more than corporate law. Despite corporate scholars' nearly exclusive focus on corporate law mechanisms for controlling managerial agency costs, shareholders are not the only constituency concerned with such costs. Given the thick web of firms' contractual commitments, it should not be a surprise that other financial claimants may also attempt to control agency costs in their contracts with the firm. We hypothesize that this cross-monitoring by other claimants has value for shareholders.
We examine bank loans for empirical evidence of the value of cross-monitoring. Our approach builds on prior empirical work on the value of good corporate governance, to which we add data on the presence of bank loans and their interactions with free cash flow, governance indices, and individual corporate governance provisions. We find strong evidence that bank monitoring adds value. In effect, bank monitoring can counteract somewhat the value-decreasing effects of managerial entrenchment. Bank monitoring may substitute for good corporate governance.
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