Corporate Cash Holdings and CEO Compensation Incentives
39 Pages Posted: 24 Oct 2009 Last revised: 16 Dec 2010
Date Written: October 25, 2010
We examine the effect of CEO compensation incentives on corporate cash holdings and the value of cash to better understand how compensation incentives designed to enhance the alignment of manager and shareholder interests may influence stockholder-bondholder conflicts. We find a positive relation between CEO risk-taking (vega) incentives and cash holdings, and we find a negative relation between vega and the value of cash to shareholders. The negative effect of vega on the value of cash is robust after controlling for corporate governance, is stronger in firms with high leverage, is reversed for unlevered firms, and is not present in financially constrained firms. We also find that the likelihood of liquidity covenants in new bank loans is increasing in CEO vega incentives. Our evidence primarily supports the costly contracting hypothesis, which asserts that bondholders anticipate greater risk-taking in high vega firms and therefore require greater liquidity.
Keywords: Cash Holdings, Value of Cash, Managerial Incentives
JEL Classification: G30, G32, G34
Suggested Citation: Suggested Citation