Governance-Default Risk Relationship and the Demand for Intermediated and Non-Intermediated Debt
Aldamen, Husam, Duncan, Keith, Khan, Safdar, Australasian Accounting Business & Finance Journal
This paper explores the impact of corporate governance on the demand for intermediated debt (asset finance, bank debt, non-bank private debt) and non-intermediated debt (public debt) in the Australian debt market. Relative to other countries the Australian debt market is characterised by higher proportions of intermediated or private debt with a lower inherent level of information asymmetry in that private lenders have greater access to financial information (Gray, Koh & Tong 2009). Our firm level, cross-sectional evidence suggests that higher corporate governance impacts demand for debt via the mitigation of default risk. However, this relationship is not uniform across all debt types. Intermediated debt such as bank and asset finance debt are more responsive to changes in governance-default risk relationship than non-bank and non-intermediated debt. The implication is that a firm's demand for different debt types will reflect its governance-default risk profile.
Key Words: Corporate governance, default risk, intermediated debt, non-intermediated debt, endogeneity, 2-stage least squares
JEL Codes: M40, M41
(ProQuest: ... denotes formulae omitted.)
We examine the impact of the corporate governance-default risk relationship on the demand for intermediated and non-intermediated debt in Australia. There is a relatively new but growing literature that links corporate governance, accounting information and debt contracting (Armstrong, Guay & Weber 2010). However, most of this research is United States (US) centric and has largely focused on the drivers of non-intermediated (public) debt pricing (Anderson, Mansi & Reeb 2004; Ashbaugh-Skaife, Collins & LaFond 2006; Bhojraj & Sengupta 2003; Mansi, Maxwell & Miller 2004; Sengupta 1998). In contrast, the Australian corporate debt market is dominated by intermediated or private debt, with relatively low levels of non-intermediated debt (Reserve Bank of Australia 2005). More importantly, the Australian debt market arguably has lower inherent information asymmetry, relative to other countries, due to the continuous disclosure regulations which ensure private lenders have greater access to financial information (Gray et al. 2009). Despite this unique market characteristic, recent research finds good accruals quality reduces the cost of debt (Aldamen & Duncan 2011b; Gray et al. 2009) but governance and default risk only impact the cost of non-intermediated (not intermediated) debt (Aldamen & Duncan 2011a). However, as Armstrong et al.'s, (2010) review notes, to date the literature has generally ignored the relationship between other debt contracting parameters, such as the demand for different types of debt, and the firm's corporate governance and accounting information characteristics. We address this gap in the literature and build on the work of Aldamen and Duncan (2011a) to explore the impact of different corporate governance-default risk relationships on the demand for different types of debt.
Wang and Lin (2010) find that default risk reduces significantly as the number of corporate governance provisions adopted increases. Furthermore, Armstrong et al.'s, (2010) review suggests that different segments in the debt market (i.e. debt types and lenders in each category) have different corporate governance-default risk preferences and that this heterogeneity is a function of firms' economic characteristics. Firms will demand more of the debt type that matches their extant governance-default risk characteristics. In our analysis we focus on the relative levels of each debt type across firms, rather than capital structure questions that are dealt with extensively elsewhere, and distinguish between two broad debt types, intermediated and non-intermediated debt (Cantillo &and Wright 2000; Denis & Mihov 2003). The greater monitoring information available to Australian intermediated debt providers potentially reduces the default risk mitigating effect of good corporate governance and differentially impacts the demand for intermediated versus non-intermediated debt relative to debt providers in other countries. …