Board members’ legal infractions and the agency cost of debt: Evidence from small business bankruptcies
Abstract We study how board members’ attitudes to risk, as measured by their personal legal infractions, are related to information asymmetry and agency problems prior to bankruptcy, using a sample of 260 small Swedish firms. We find that auditor resignations are more likely in firms where at least one board member has a legal infraction. Furthermore, we find that legal infractions are negatively related to the likelihood of a firm disclosing its annual report and the quality of the bookkeeping, suggesting that information asymmetry problems are more severe when board members have legal infractions. We also find that creditors’ recovery rates in bankruptcy are lower if board members have legal infractions, indicating that the agency costs of debt are higher. A final finding is that auditor resignations seem to transmit the association between legal infractions and creditors’ recovery rates.