How does the CEO horizon problem affect the cost of bank loans?

Abstract

In this paper, we investigate the effect of the CEO horizon problem on the cost of bank loans. Prior research suggests that CEOs at the end of their tenures become myopic and have fewer incentives to act in the best interests of their firms, creating a CEO horizon problem. We predict and find that loan spreads significantly increase in the last two years, especially in the final year, of a CEO's tenure. Further analyses reveal firms with a lower credit rating, without a prior relationship with the bank, and with planned CEO departures exhibit a stronger main effect, suggesting a change in a bank's risk tolerance as a potential mechanism. Next, we find that the main effect is more pronounced for firms with weaker corporate governance. In addition, we rule out incompetent CEOs, uncertainty associated with the new CEO, and the earning management effect as alternative explanations. Our paper contributes to the recent research investigating how executive characteristics, specifically the CEO horizon problem, influence the cost of bank loans.