Financial Distress Risk and New CEO Compensation

Management Science

51 Pages Posted: 13 Jun 2015

See all articles by Woo-Jin Chang

Woo-Jin Chang

INSEAD; Independent

Rachel M. Hayes

University of Utah - David Eccles School of Business

Stephen A. Hillegeist

Arizona State University (ASU) - W. P. Carey School of Business, School of Accountancy

Date Written: November 30, 2014

Abstract

We examine how ex ante financial distress risk affects CEO compensation. In order to disentangle the joint effects of performance on compensation and distress risk, we focus our analyses on new CEOs. Our results indicate financial distress risk affects compensation through two channels. First, new CEOs receive significantly more compensation when financial distress risk is higher. This finding is consistent with CEOs receiving a compensation premium for bearing this risk since CEOs experience large personal costs if their firms later become financially distressed. Second, financial distress risk is associated with the incentives provided to new CEOs; distress risk is positively associated with pay-performance sensitivity and equity-based compensation and is negatively associated with cash bonuses. Further, financial distress risk is positively associated with pay-risk sensitivity for new CEOs. These findings suggest financial distress risk alters the nature of the agency relationship in ways that lead firms to provide CEOs with more equity-based incentives. We also build on research that finds a positive relation between forced turnover risk and CEO compensation. Our analyses suggest the compensation effects of forced turnover risk appear to be mainly attributable to financial distress risk. Overall, our results indicate that financial distress risk is an economically important determinant of new CEO compensation packages.

Keywords: CEO compensation, compensation premium, CEO incentives, financial distress risk

JEL Classification: J33, J24, J41, G33

Suggested Citation

Chang, Woo-Jin and Hayes, Rachel M. and Hillegeist, Stephen A., Financial Distress Risk and New CEO Compensation (November 30, 2014). Management Science, Available at SSRN: https://ssrn.com/abstract=2617846

Woo-Jin Chang

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

Independent

No Address Available
United States

Rachel M. Hayes

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Stephen A. Hillegeist (Contact Author)

Arizona State University (ASU) - W. P. Carey School of Business, School of Accountancy ( email )

Tempe, AZ 85287-3706
United States
480-965-6614 (Phone)

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