Are Executive Pensions and Deferred Compensation Inside Debt? Evidence from Corporate Private Loan Contracts

Abstract:     
Theory posits that inside debt (such as defined-benefit pensions and other deferred compensation) aligns managerial incentives with those of debtholders and reduces the agency cost of debt. Consistent with debtholders perceiving an incentive-alignment effect of inside debt, we find that a higher CEO relative leverage, defined as the ratio of the CEO's inside leverage (inside debt holding over inside equity holding) to corporate leverage, is associated with lower promised yield and fewer covenants, for a sample of private loans originated during 2006-2008. These findings persist after accounting for endogeneity and are more pronounced for firms with higher default risk. Further analyses show that the perceived incentive-alignment effect is driven by inside debt that more closely resembles risky corporate debt in payoffs, and weakens when the CEO has the option to withdraw inside debt claims prior to general debtholders. Overall, we show that private lenders recognize not only the incentive-alignment effect of inside debt but also the extent to which each form of inside debt is truly debt-like, and adjust the terms of debt contracts accordingly.

Number of Pages in PDF File: 57

Keywords: Executive Compensation, Inside Debt, Corporate Debt Contracts

JEL Classification: G32, G34, J33, M12

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