The Salience of Creditors' Interests and CEO Compensation

Abstract

This paper shows that firms adjust CEO compensation policies when creditors' interests are more salient. This effect helps explain controversial compensation practices such as weak performance incentives and short pay duration. Our findings also show that to mitigate the agency cost of debt, compensation contracts can reflect not only the firm's capital structure but the debt contract itself. For example, firms tend to contract on accounting-based goals when creditors do as well. Our analysis relies on a regression discontinuity design around loan covenant violations. We also confirm our conclusions studying a broad sample of financially constrained firms seeking debt financing.

Keywords: CEO Compensation, Creditors' Interests, Debt Contracting

JEL Classification: G32, G34, J33