Exploring the agency cost of debt: risk, information flow, and CEO social ties

Abstract

Contrary to the findings of prior research that focuses on private loans and bank debt, we find that greater CEO social capital is positively associated with a firm’s cost of public debt. This effect is particularly pronounced for firms in financial distress and firms with a higher probability of default that increase dividends. Examining the channel, we demonstrate that social capital is associated with a reduced use of restrictive covenants, which subsequently amplifies the firm's cost of debt. Collectively, the results support the risk-shifting perspective as a plausible mechanism. Our findings remain robust when considering alternative proxies for social capital, alternative model specifications, and tests for endogeneity.