The Unbearable Weight of the Past

THE PAST EXPERIENCE AND PROFESSIONAL BACKGROUNDS OF THE MEMBERS OF BOARDS OF DIRECTORS MATTER ESPECIALLY IN CASE OF BANKRUPTCY AND ARE CAREFULLY STUDIED BY CAPITAL MARKETS. ONE STUDY SHOWS THAT SUCH EXPERIENCE IS ASSOCIATED WITH AN INCREASE IN CREDIT SPREAD OF 20.4 BASIS POINTS AND A DECREASE IN BOND SIZE OF 22.6% ON AVERAGE

by Stefano Gatti, Antin IP Professor of Infrastructure Finance, Bocconi University

The role of the Board of Directors in determining the success of a corporation has never been debated as today. The enactment of the SHRD II and of the SFDR has put the shareholders under the spotlight, giving them a more active role in shaping boards’ decisions.

In this debate, the importance of board members’ past professional experience becomes essential. A skilled board of directors should be in the best position to engage not only with shareholders but also with all the stakeholders of the firm: customers, suppliers, creditors, employees and Institutions.

In our recent paper entitled “Corporate bankruptcy and directors’ reputation: an empirical analysis of the effects on public debt contracts”, we study a very specific relation: the link between board members’ past professional experiences and the terms and conditions of the debt contracts of their current firms. Overall, we suggest that lenders incorporate information about past professional experiences of directors into public debt contracting.
We examine whether directors' past bankruptcy experience at other firms affects the pricing – essentially the interest rate/credit spread – and non-pricing terms – raised amount of funds and funds maturity – of bond issues in primary markets. Our intuition is that if a firm hires a director who has been involved in prior bankruptcy cases, outside lenders interpret this choice as negative for the hiring firm. In fact, this director could contribute to increase the risk-taking appetite of the company and/or to modify the investment choices of the firm. Clearly, these aspects threaten the core of good corporate governance practice, if these behaviors are not properly checked and monitored.

The sample of our study is based on 8,142 bond issues in the U.S. in the decade 1995-2015, we find higher credit spreads and smaller bond sizes for firms with such directors. This suggests that bondholders are concerned about past bankruptcy experience and that they react with less favorable terms and conditions when purchasing such bonds at issue. More precisely, we document that the presence of a director with past bankruptcy experience is associated with an increase in credit spread of 20.4 basis points and a decrease in bond size of 22.6 percent on average.

The effect of directors’ past bankruptcy experience on credit spread and bond size is more limited for bankruptcies that are determined by exogenous/non idiosyncratic shocks such as the dotcom bubble and the global financial crisis. We also show that our findings are not explained by bond issuers with a high risk of default (high yield issuers). Instead, results seem to be driven by the specific role played by the directors inside the board, for example serving on key monitoring committees. This is a clear signal that prior bankruptcy experience raises concerns about the company’s corporate governance. Lastly, we find some evidence of a limited negative indirect effect of prior bankruptcy experience on the terms of debt contracts through the firm’s financial and investment policies.

To summarize, our paper indicates that the professional background and experience of Board members are taken into great consideration by capital markets, even more so if the director has served in companies that went bankrupt and more yet if they served in key committees of the same board. Policymakers seem to be acting as suggested in the paper. For example, the recent Decree of the Ministry of Economy and Finance (Decree November 23, 2020 nr. 169) has strengthened the criteria to be met in order to take positions as board members in financial institutions and financial intermediaries, focusing on the past professional experience of candidates.