Trust and Debt Contracting: Evidence from the Backdating Scandal

Veljko Fotak, Feng (Jack) Jiang, Haekwon Lee, and Erik Lie

We study the effect of trust on debt contracting. We find that, after the revelation of option backdating, borrowers that likely backdated their previous option grants pay higher interest rates on loans. This adverse effect is mitigated by CEO replacements. Results are similar for public debt, but only if a third party identified the backdaters. After the backdating revelation, firms that engaged in backdating increase their reliance on public debt, and those without access to the public debt market experience capital constraints.