The impact of board gender composition on loan covenant violations

• Published date: 01 July 2024
• Author: Md Samsul Alam,Muhammad Atif,Douglas Cumming,Md Shahidul Islam
• Date: 01 July 2024
• DOI: http://doi.org/10.1111/corg.12561

ORIGINAL ARTICLE

The impact of board gender composition on loan covenant

violations

Md Samsul Alam

1

| Muhammad Atif

2

| Douglas Cumming

3,4

|

Md Shahidul Islam

5

1

Derby Business School, University of Derby,

Derby, UK

2

Department of Accounting and Corporate

Governance, Macquarie Business School,

Macquarie University, Sydney, Australia

3

College of Business, Florida Atlantic

University, Boca Raton, Florida, USA

4

Birmingham Business School, University of

Birmingham, Birmingham, UK

5

Essex Business School, University of Essex,

Colchester, UK

Correspondence

Douglas Cumming, College of Business, Florida

Atlantic University, 777 Glades Road, Boca

Raton, FL 33431, USA.

Email: cummingd@fau.edu

Abstract

Research Question/Issue: We examine the role of board gender diversity in attenu-

ating loan covenant violations. We also investigate whether the relationship is influ-

enced by female independent directors. Finally, we examine the channels of this

relationship.

Research Findings/Insights: Drawing on gender socialization and diversity theories,

our findings show that firms with gender-diverse boards are less likely to violate loan

covenants. We also find that boards with more female directors have a stronger

impact on loan covenant violations than those with fewer female directors, consis-

tent with critical mass theory. Our results also suggest that the negative relationship

stems from female independent directors rather than from female executive direc-

tors. Our channel analyses indicate that the relationship is routed through covenant

strictness, the financial performance of firms, and better corporate governance. Our

further analysis demonstrates that the relationship is pronounced in female-

dominated industries and financially distressed firms, as well as in firms whose direc-

tors have greater experience. Our results are robust across a series of sensitivity and

endogeneity tests.

Theoretical/Academic Implications: We contribute to an emerging strand of litera-

ture that examines the link between board gender diversity and loan covenants. We

fill a gap in this stream of literature by providing the first empirical evidence that

female directors in the boardroom reduce loan covenant violations through their

greater integrative bargaining skills during loan deals, improving firm financial perfor-

mance, and ensuring good corporate governance. Our study also contributes to the

growing literature on the differential effects on corporate policies of female directors

(independent and executive) and critical mass.

Practitioner/Policy Implications: This finding offers significant policy implications for

managers, investors, and policymakers. Given the growing frequency of loan cove-

nant violations, the presence of a gender-diverse board should serve as a potent indi-

cator to creditors who have a concern regarding loans. In addition, our study adds to

the ongoing debate regarding the business case of board gender diversity.

Received: 11 July 2022 Revised: 5 September 2023 Accepted: 8 September 2023

DOI: 10.1111/corg.12561

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium,

provided the original work is properly cited.

© 2023 The Authors. Corporate Governance: An International Review published by John Wiley & Sons Ltd.

Corp Govern Int Rev. 2024;32:703–731. wileyonlinelibrary.com/journal/corg 703

KEYWORDS

corporate governance, board gender diversity, covenant violations

1|INTRODUCTION

Loan covenants are usedby lenders as tools in loan contracts to moni-

tor borrowers(Chava & Roberts, 2008). The violation of suchcovenants

over the course of a loan is a technical default for firms that grant

lenders temporary control rights over borrowers (Garleanu &

Zwiebel, 2009; Roberts & Sufi, 2009). The violation of loan covenants

indicates that firmsrequire intense monitoring, incuradditional costs in

renegotiating loan contracts, and face issues in future loans (Nini

et al., 2012). Theseviolations further translate intopronounced costs in

terms of value destruction to shareholders (Beneish & Press, 1993;

Chava & Roberts,2008;Falato&Liang,2016). Extant literature concurs

that board characteristics affect loanpricing and non-pricing provisions,

including loan maturity, size, and covenant requirements (Lin

et al., 2016). An extensivepart of this literature suggests that a gender-

diverse board is conducive for shareholders and other stakeholders of

firms due to its monitoring effects (Adhikari et al., 2019;Atif

et al., 2021;Casuetal.,2023; Cumming et al., 2015;DeAmicis&Falco-

nieri, 2023; Dimungu-Hewage & Poletti-Hughes, 2023;Falconieri&

Akter, 2023) and that femaleleaders exhibit less vague corporate com-

munications (De Amicis et al., 2021; De Amicis & Falconieri, 2023).

Understanding what benefits gender-diverse boards can provide with

respect to covenant violations is a vital concern, giventhe higher costs

associated withthese violations. This study helpsto reduce the scarcity

of research in the area by investigating whether board genderdiversity

attenuatesloan covenant violations.

While there may be some overlap between financial misconduct

and covenant violations, we argue that there are definite differences

between them. Financial misconduct indicates any unethical and

illegal behavior regarding financial matters, including embezzlement,

fraud, insider trading, money laundering, and other forms of financial

mismanagement (Koch-Bayram & Wernicke, 2018; Raghunandan, 2021).

Financial misconduct may lead to fines, criminal charges, and

imprisonment. It can also have severe consequences for a company's

reputation and the trust of its investors and stakeholders (Zaman

et al., 2022). On the other hand, loan covenant violations refer to

breaches of the terms and conditions outlined in a contractual loan

agreement between lenders and borrowers. These covenants include

both financial and non-financial requirements and limitations

regarding payment terms, maintenance and operation obligations,

and performance benchmarks (Demiroglu & James, 2010; Lim

et al., 2020).

While covenant violations may not largely involve illegal behavior,

they could result in profound consequences for both parties. Unlike

financial misconduct, covenant violations may have an immediate

impact on a firm's capital reserves as such breaches may cause loan

contract termination, which could result in urgent loan repayment,

collateral seizing, and legal action against the borrower (Beneish &

Press, 1993; Chava & Roberts, 2008). Moreover, the consequences of

violating loan covenants can vary depending on the type of covenant

and the severity of the violation (Dyreng et al., 2022). For example, if

a borrower triggers an event of default, the lender may accelerate the

repayment of the loan, demand immediate repayment of the out-

standing balance, and take legal action to recover the outstanding

debt. However, if a borrower fails to disclose the required information

by the loan agreement, the lender may ask the borrower to provide

additional information and comply with the loan agreement. Overall,

financial misconduct and covenant violations are significantly different

in nature as they have distinct implications and consequences.

We draw arguments based on negotiation skills and monitoring

perspectives to postulate that board gender diversity reduces loan

covenant violations. More specifically, we refer to gender behavior

theory that emphasizes female directors are significantly different

from their male peers in terms of their behavior and cognition. For

example, female directors spend more time in preparation to under-

stand and analyze information involved in financial transactions and

dealings. In addition, female directors are more collaborative, coopera-

tive, and trustworthy (Liu et al., 2014; Perrault, 2015; Strøm et al.,

2023), which can be crucial during the negotiation of a loan deal,

thereby lowering the covenant restriction and probability of loan cov-

enant violations. Second, gender socialization theory implies that

women are less overconfident (Larkin et al., 2013; Levi et al., 2014;

Matsa & Miller, 2013) and prudent risk takers (Chen et al., 2017) com-

pared with their male counterparts. Thus, female directors may priori-

tize financial security and stability, leading to more equitable and

inclusive loan dealings. Finally, the agency theory postulates that

female directors put more emphasis on monitoring through frequently

organizing board meetings and ensuring better attendance to them

(Adams & Ferreira, 2009; Goergen & Renneboog, 2014). Enhanced

board monitoring increases corporate governance and, thus, its ability

to reduce loan covenant violations.

The follow-up question is how board gender diversity influences

covenant violations. We argue that board gender diversity is likely to

influence covenant violations both directly and indirectly. From a

direct perspective, women have superior communication skills and

spend more time preparing and analyzing deal information, leading to

greater integrative bargaining skills in financial dealings (Kray

et al., 2001; Mazei et al., 2015). Hence, firms with more female direc-

tors may be better able to negotiate loan deals with less strict cove-

nants, which, in turn, results in less likelihood of covenant violations.

However, one may argue that female directors indirectlyinfluence

covenant violations through the firms' financial policies (i.e., improving

financial performance and reducing financial risk). Prior studiesprovide

considerable evidence that board gender diversity is positively associ-

ated with firm financial performance (Brahma et al., 2021;Liu

et al., 2014), which,in turn, assists financially improvedfirms in meeting

704 ALAM ET AL.