Do Bondholders Care About Managerial Stability? Evidence from the Financial Services Industry

Using new bond issues in the financial services industry, this study examines whether and to what extent the capital markets recognize the risk associated with the mobility of human capital. We evaluate the state-by-state variations in the enforceability of noncompetition agreements in the United States to test the market-discipline hypothesis and find a significant negative relation between the degree of enforcement of noncompetition agreements and the yield spreads for bonds issued by financial institutions. We also find that the negative relation is more prominent for investment-grade bonds and bonds with long-term maturities. In addition, we find that investors care more about managerial stability when bond issuers have weak protection of shareholder rights. Given the extreme importance of human capital in the financial services industry and the heightened turnover rate in the industry, our study sheds further light on the importance of intangible assets in shaping the perception of firm risk. Moreover, our paper also establishes another robust link between law and finance in the sense that the regulatory environment has a significant effect on the cost of debt for financial firms