Creditor Control Rights and Executive Bonus Plans
89 Pages Posted: 19 Jan 2022 Last revised: 8 Jan 2024
Date Written: January 2, 2024
Abstract
We study the extent to which creditors shape the executive bonus plans of their financially distressed borrowers. Financial distress can exacerbate agency conflicts between creditors and borrowers as concerns with underinvestment become more acute due to managerial myopia and debt overhang. Consequently, we expect creditors to exert their influence to ensure that these managers’ incentive-compensation plans encourage longer-term investments and directly reward outcomes that benefit creditors without exposing managers to unnecessary risk. We argue that bonus plans are an especially important way to provide these incentives because their flexibility allows creditors to more precisely (vis-à-vis equity) target specific investment objectives. We find that borrowers’ bonus plans tend to have longer horizons and more convex payouts following covenant violations, especially for those in poor financial health and where bonus plans are most likely to be effective at addressing financial distress-related agency conflicts. Our evidence suggests that creditors protect their interests by exercising their control rights to shape the incentive-compensation plans of their borrowers.
Keywords: bonus plans, control rights, creditors, executive compensation, managerial incentives
JEL Classification: G34, J3, M12
Suggested Citation: Suggested Citation