Inside Debt and the Design of Corporate Debt Contracts
Rutgers, The State University of New Jersey - Accounting & Information Systems
Vivian W. Fang
University of Minnesota - Twin Cities - Department of Accounting
Penn State University - Smeal College of Business
January 19, 2011
Fifth Singapore International Conference on Finance 2011
Agency theory posits that debt-like compensation (such as defined-benefit pensions and other deferred compensation) aligns managerial interests more closely with those of debtholders and reduces the agency cost of debt. Consistent with theory, we find that a higher CEO relative leverage, defined as the ratio of the CEO's inside leverage (debt-to-equity compensation) to corporate leverage, is associated with lower cost of debt financing and fewer restrictive covenants, for a sample of private loans originated during 2006-2008. These findings persist after accounting for the endogeneity of CEO relative leverage, and are more pronounced for firms with higher default risk. Additional analysis on a sample of new public bond issues also shows a negative relation between CEO relative leverage and bond yield spread. Overall, the evidence supports the notion that debtholders recognize the incentive effects of executive debt-like compensation and adjust the terms of corporate debt contracts accordingly.
Number of Pages in PDF File: 56
Keywords: Executive Compensation, Inside Debt, Debt Contracting
JEL Classification: G32, G34, J33, M12working papers series
Date posted: January 20, 2011
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