Board Liability Limitation, Indemnification and the Cost of Debt

Abstract

We document a strong negative relation between the presence of director liability limitation and indemnification-L-index, and the cost of debt. Surprisingly, we find little evidence that firms with higher L-index attracts directors with expertise, the only mechanism through which L-index benefits bondholders based on extant literature. Directors with higher L-index set lower pay-for-performance sensitivity for CEO, which harm bondholders. Unexpectedly, firms with higher L-index seem to take less risk, not more, that may benefit bondholders. After controlling for L-index, G-index is associated with higher cost of debt, which may suggest the beneficial effect of takeovers on bondholders.