January 17, 2007
Cross-Monitoring and Corporate Governance
Posted by Fred Tung

I'll be presenting Cross-Monitoring and Corporate Governance at Michigan in a few weeks.  The paper, co-authored with Joanna Shepherd and Albert Yoon, offers empirical evidence that bank monitoring improves firm value and may substitute for good corporate governance.  Here's the 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.

While the corporate finance literature has recognized that bank monitoring may benefit shareholders, corporate law scholars have not paid much attention to the potential value of cross-monitoring.  Notable exceptions include Triantis and Daniels (WL), who published a paper in 1995 on creditors' role in a system of interactive corporate goverance, and Baird and Rasmussen, who've recently called our attention to the importance of creditor influence on management (here and here).  Our paper tests the value of cross-monitoring empirically, interacting the presence of bank loans with governance indices (the G-index and E-index) and individual governance provisions, as well as with free cash flow.  Comments appreciated!


Corporate Governance, Corporate Law, Empirical Legal Studies | Bookmark

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