54 Pages Posted: 14 Mar 2012 Last revised: 14 Sep 2014
Date Written: August 2013
We analyze whether paying CEOs with inside debt (pensions and deferred compensation) benefits shareholders. We find that stock price reaction to initial revelation of inside debt information following the SEC amendment is significant and positive, albeit delayed. In the subsequent revelation of information pertaining to the use of inside debt for firms that disclosed no inside debt compensation in the first revelation, the stock price response is immediate and significantly positive. In the recent financial crisis, firms that use a combination of inside debt and equity in compensating their CEOs had better stock price performance than firms that pay their CEOs with equity, but no inside debt. Both groups of firms did not perform substantially different in post-crisis. During the crisis, among firms that use inside debt, firms that employ a debt bias in compensation (debt-to-equity compensation of the CEO exceeds the corporate leverage ratio) performed better than firms that employ an equity bias. Our evidence support Edmans and Liu (2011)’s theoretical propositions that optimal level of inside debt is positive, pure equity compensation is inefficient and, that a debt bias is desired when insolvency is likely. Findings have implications for firms and policymakers in terms of risk management through managerial compensation. We deduce that inside debt also enhances hedging possibilities for stock investors through stock selection and portfolio choice.
Keywords: Inside debt, defined benefit pensions, deferred compensation, managerial incentives, abnormal return
JEL Classification: G12, G14, G32, M52
Suggested Citation: Suggested Citation
By Wei Cen