Are Directors Really Irrelevant to Capital Structure Choice?

André Gygax is on the finance faculty at the University of Melbourne. This post is based on a recent paper authored by Mr. Gygax; Matthew Hazledine, Department of Finance at the University of Melbourne; and J. Spencer Martin, Professor of Finance at the University of Melbourne.

Theories of capital structure typically say that the optimal level of debt depends on the characteristics of a firm, such as volatility of its business, and environmental variables such as tax rates and interest rates. Thus, other things equal, the 35-year fall in 10-year bond yields over the 1981-2016 period would be expected to lead to significant increases in corporate leverage. Instead, Lemmon, Roberts and Zender (2008) find that firms persist a long time in their choice for high or low borrowing levels. Complicating the picture, DeAngelo and Roll (2015) find that differences in leverage across firms are highly volatile, more so than the range of firm characteristics influencing capital structure. They suggest broadening existing analyses to incorporate “managerial attitudes and social norms about debt.”

In our study, Are Directors Really Irrelevant to Capital Structure Choice?, we note that it is within the fiduciary duties of a board of directors to engage seriously with executive management to determine an appropriate level of debt. In this decision making setting, the board’s knowledge and experience form a key resource. More particularly we argue that one important channel for flow of external knowledge and expertise is the board interlocking network, using linkages created when a director sits on multiple boards. We investigate whether and how the board interlocking network helps explaining observed capital structure dynamics and clustering. The research method is to analyze the dynamic effects of the board interlocking network on observed leverage ratios.

Building on resource dependence theory (Pfeffer and Salancik, 1978) we argue that when boards assess capital structure choice, directors may go beyond monitoring management and providing strategic advice; they also provide access to scarce external resources through corporate network ties. We argue that membership on other boards offers access to a wide range of experiences that complement focal firm knowledge. This is in line with the growing empirical evidence that network ties are an important consideration in understanding corporate behavior in the context of other financial decisions such as executive compensation, mergers & acquisitions, fund management or venture capital.

The methodology is to estimate a statistical modeling of the co-evolution of the interlocking board network and capital structure choices. The stochastic actor-oriented model (SAOM) introduced by Snijders (2001), uses probabilistic simulation to determine which factors are important in explaining the evolution of observed leverage over time. The model is particularly designed to distinguish between selection effects (firms of similar leverage choosing to share a director), and influence effects (firms sharing a director tend to converge on similar leverage). Our sample is S&P 500 firms over the period 2001-2010.

Our empirical results provide strong support for the influence hypothesis that the financial leverage of firms is influenced by existing director ties. Second, while our results mostly reject the selection hypothesis, we do find some support for it when using the Welch (2004) measure of leverage instead of the standard book and market leverage ratios. Third, our analysis shows that after controlling for these network effects, there is weak evidence for the involvement of factors empirically shown to affect capital structure.

The main contribution of our study is that it provides simple, clear evidence that director network influence effects play an important incremental role in explaining observed capital structures of S&P 500 constituent firms. As the estimated dominant network effect is influence rather than selection our results have important potential implications for better corporate governance. In addition, our results lend support to DeAngelo and Roll’s (2015) findings that firms actively change their debt levels over even shorter periods.

The full paper is available for download here.


DeAngelo, Harry, and Richard Roll, 2015. How stable are corporate capital structures? Journal of Finance 70, 373-418.

Lemmon, Michael L., Michael R. Roberts, and Jaime F. Zender, 2008. Back to the beginning: Persistence and the cross-section of corporate capital structure, Journal of Finance 63, 1575–1608.

Pfeffer, J., and G. R. Salancik, 1978. The external control of organizations: A resource dependence perspective. New York: Harper & Row.

Snijders, Tom A. B., 2001. The statistical evaluation of social network dynamics, Sociological Methodology 31, 361–395.

Welch, Ivo, 2004. Capital structure and stock returns, Journal of Political Economy 112, 106-131.

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