The False Promise of Risk-Reducing Incentive Pay: Evidence from Executive Pensions and Deferred Compensation
Kelli A. Alces
Florida State University - College of Law
Brian D. Galle
Boston College Law School
April 11, 2012
38 Journal of Corporation Law 53 (2012)
Boston College Law School Legal Studies Research Paper No. 266
FSU College of Law, Public Law Research Paper No. 600
FSU College of Law, Law, Business & Economics Paper No. 12-9
The average publicly-traded firm pays its CEO millions of dollars in deferred compensation and defined-benefit pension commitments. Scholars debate whether firms use these payments to efficiently align managerial interests with those of creditors, or whether instead they represent “hidden” forms of rent extraction. Yet others recommend these forms of debt-like incentive compensation, sometimes called “inside debt,” as a way of controlling risk-taking in systemically important financial institutions.
We argue instead that inside debt is unlikely to be efficient in either setting. Inside debt is costlier and more complex than other tools for managing risk, such as covenants or simply cutting back on option pay, and gives managers opportunities to hedge their equity positions without revealing that fact to investors. Drawing on the behavioral literature, we also show that increasing pay complexity is likely to reduce the efficacy of all forms of manager incentives.
To test these hypotheses, we conduct a series of panel regressions utilizing matched CEO and firm data covering over 1300 firms during the period 2007 to 2009. Under most specifications, we find little evidence that current borrowing needs correspond with executive pay structures. We do find, however, significant relations between the use of pensions and markers of managerial power, markers of board risk aversion, and lagged firm debt levels.
Number of Pages in PDF File: 49
Keywords: inside debt, incentive pay, pay for performance, managerial power, bankruptcy, corporate credit, risk regulation
JEL Classification: D23, G21, G33, G34, J33, K22, M52Accepted Paper Series
Date posted: April 11, 2012 ; Last revised: March 22, 2013
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