Inside Debt and the Design of Corporate Debt Contracts

Management Science, May 2014, 60 (5), 1260-1280.

37 Pages Posted: 26 Oct 2010 Last revised: 12 Feb 2015

See all articles by Divya Anantharaman

Divya Anantharaman

Rutgers, The State University of New Jersey - Accounting & Information Systems

Vivian W. Fang

European Corporate Governance Institute (ECGI); Indiana University

Guojin Gong

University of Connecticut

Date Written: August 18, 2013

Abstract

Theory posits that managerial holdings of debt (“inside debt”) align managers’ incentives with those of outside debtholders. Executive pensions, which consist of ERISA-qualified rank-and-file (RAF) plans and Supplemental Executive Retirement Plans (SERPs), and other deferred compensation (ODC) have debt-like payoffs, and could therefore function as inside debt. However, while SERPs are often unfunded and unsecured, RAF plans are funded and secured to some extent, and ODC may be invested in equity and withdrawn flexibly pre-retirement. Special arrangements in executive debt-like compensation could weaken or even nullify the incentive-alignment effect. We find that larger CEO debt-like compensation leads to lower promised yield and fewer covenants in a sample of loans originated in 2006-2008. This effect is driven entirely by benefits accrued under SERPs, consistent with SERPs more closely resembling risky corporate debt; balances accrued under RAF and ODC plans do not provide similar effects. Further, promised yields are lower when debt-like compensation claims can be withdrawn only after outside debt claims settle. Our findings persist after accounting for endogeneity using state personal income tax rates as an instrument for CEOs’ willingness to defer compensation. Overall, the evidence suggests that executive debt-like compensation is only effective at resolving stockholder-debtholder conflicts when its payoffs are truly debt-like, and that lenders’ perceptions are affected not only by the magnitude of debt-like compensation but also by its seniority.

Keywords: Executive Compensation, Inside Debt, Corporate Debt Contracts

JEL Classification: G32, G34, J33, M12

Suggested Citation

Anantharaman, Divya and Fang, Vivian W. and Gong, Guojin, Inside Debt and the Design of Corporate Debt Contracts (August 18, 2013). Management Science, May 2014, 60 (5), 1260-1280., Available at SSRN: https://ssrn.com/abstract=1697855 or http://dx.doi.org/10.2139/ssrn.1697855

Divya Anantharaman (Contact Author)

Rutgers, The State University of New Jersey - Accounting & Information Systems ( email )

1 Washington Park
#916
Newark, NJ 07102
United States

Vivian W. Fang

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Indiana University ( email )

Bloomington, IN 47405
United States
47405 (Fax)

Guojin Gong

University of Connecticut ( email )

Storrs, CT 06269
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
1,415
Abstract Views
14,139
Rank
25,416
PlumX Metrics