The Relationship between Board Independence and the Cost of Bank Debt

Abstract

ABSTRACT This paper studies the relationship between the independence of a board of directors and the cost of bank loans during the post-SOX Act era. In comparison with loans borrowed by firms that have boards with fewer independent directors than the sample mean (84%), loans initiated by firms with high board independence have statistically significant lower spreads (by 22 bps) and higher facility amounts (almost 35%), as well as being less secure. These results are consistent with banks using lower loan prices because firms with more board independence experience fewer problems and costs associated with monitoring and operational risk. The results imply economically significant evidence that maintaining a board with more than the mean of independent members lowers the cost of bank debts, making it possible to maintain larger amounts of debt. These are indicators of valuable corporate governance practices, which reflect the crucial influence that the proportion of independent board members has on the cost of debt. The results show that a 1% increase in the independence of the board’s composition reduces the cost of bank loans by 0.13%.