Co-opted boards and capital structure dynamics

This study examines the effects of co-opted directors and further tests the monitoring effectiveness of non-co-opted independent directors and co-opted independent directors on capital structure decisions. Employing a large sample of 2,548 US firms over the 1996-2015 period, we find strong evidence that co-opted boards exert a positive and significant influence on firms’ financial leverage. We also find that, whereas co-opted independent directors are positively associated with financial leverage, non-co-opted independent directors have a negative influence on a firm’s leverage ratio, suggesting that co-option weakens the effective monitoring, thereby increasing the firm’s leverage ratio. Further analysis indicates that co-opted boards adjust towards target leverage levels at a faster speed, with a half-life within a year for book and market leverage. Lastly, our results show that the agency costs of managerial discretion and stockholder-bondholder conflicts arising from board co-option are important drivers of financial leverage relative to tax incentives. Our results are robust to alternative measures of board co-option, financial leverage, and endogeneity concerns.