Direct and Indirect Risk-Taking Incentives of Inside Debt
SAFE Working Paper No. 60
64 Pages Posted: 10 Jul 2014 Last revised: 20 Jul 2016
Date Written: July 16, 2016
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about the relation between credit spreads and different compensation components. First, we show that credit spreads are decreasing in inside debt only if it is unsecured. Second, the relation between credit spreads and equity incentives varies depending on the features of inside debt. We show that credit spreads are increasing in equity incentives. This relation becomes stronger as the seniority of inside debt increases. Using a sample of U.S. public firms with traded credit default swap contracts, we provide evidence supportive of the model’s predictions.
Keywords: Inside Debt, Credit Spreads, Risk-Taking
JEL Classification: G32, G34
Suggested Citation: Suggested Citation