Negative Hedging: Performance Sensitive Debt and CEOs' Equity Incentives

54 Pages Posted: 13 Nov 2008 Last revised: 23 Sep 2009

Alexei Tchistyi

University of Illinois at Urbana-Champaign - Department of Finance

David Yermack

New York University (NYU) - Stern School of Business

Hayong Yun

Michigan State University - Department of Finance

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Date Written: September 18, 2009

Abstract

We examine the relation between CEOs equity incentives and their use of performance-sensitive debt contracts. These contracts require higher or lower interest payments when the borrower's performance deteriorates or improves, thereby increasing expected costs of financial distresswhile also making a firm riskier to the benefit of option holders. We find that managers whose compensation is more sensitive to stock price volatility choose steeper and more convex performance pricing schedules, while those with high delta incentives choose flatter, less convex pricing schedules. Performance pricing contracts therefore seem to provide a channel for managers to increase firms financial risk to gain private benefits.

Keywords: Performance sensitive debt, equity compensation

Suggested Citation

Tchistyi, Alexei and Yermack, David and Yun, Hayong, Negative Hedging: Performance Sensitive Debt and CEOs' Equity Incentives (September 18, 2009). NYU Working Paper No. FIN-07-043. Available at SSRN: https://ssrn.com/abstract=1300782

Alexei Tchistyi (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

David Yermack

New York University (NYU) - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY 10012-1126
United States
212-998-0357 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~dyermack

Hayong Yun

Michigan State University - Department of Finance ( email )

645 N Shaw Lane, Room 339
East Lansing, MI 48824-1122
United States
517-884-0549 (Phone)

HOME PAGE: http://https://sites.google.com/site/hayongy/

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