Corporate governance, risk assessment and cost of debt

This paper examines the impact of corporate governance practices on the reported cost of contracted debt for Australian listed companies. Good governance decreases the variability in cash flows, reduces the probability of default (reduces default risk), increases the quality of value-relevant information disclosed (reduces the information risk) and thereby lowers the cost of debt (Ashbaugh-Skaife, Collins, and LaFond 2006; Sengupta 1998; Bhojraj and Sengupta 2003; Beekes and Brown 2006; Klein 2002; Easley and O'Hara 2004). Similarly our Australian data confirms that cost of debt is positively related to default and information risks. We show that increased corporate governance reduces default and information risk, thereby lowering cost of debt. However, small companies that adopt higher levels of corporate governance do not benefit through lower cost of debt. This raises questions about the merits of universal adoption of costly governance practices. The evidence suggests that there is a lower cost-benefit payoff for smaller firms than larger firms at least in terms of reducing the cost of debt.