Cross-Monitoring and Corporate Governance

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. To our knowledge, ours is the first study to measure the performance effects of bank debt as a device for reducing managerial agency costs, and the first study on the interaction of ongoing bank monitoring with corporate governance arrangements. 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.