Do creditors punish increased insider ownership? Evidence from India

Existing literature presents competing arguments regarding influence of insider ownership on borrowing costs for firms. A distinct strand of literature suggests that creditors may find firms with low insider control less attractive and thus may demand higher compensation while lending. However, other studies offer alternative arguments suggesting that creditors might view firms with weak insider control in more favourable way. Moreover, cost of overall borrowings, including short term borrowings, has received much less attention in the literature despite its importance to firms.
Against this backdrop, we examine the impact of change in insider ownership on the cost of borrowings in India by analysing data of publicly listed firms in India for year 2001 to 2015. Using within-firm variation over time and exogenous shock to conduct quasi-experiment, we find, consistent with our hypothesis, an inverted-U-shaped relationship between insider ownership and borrowing costs. We present compelling evidence that creditors may not just punish but may also reward increased insider ownership, depending upon pre-existing level of ownership. We find that increase in insider ownership by one percentage point initially leads to increase in borrowing costs by as much as 13 basis points. However, once insiders control approximately 37% of a firm and start approaching majority control, creditors demand lower compensation. However, we do not find influence of change in insider ownership on borrowing costs for firms where insiders maintain majority control over time.