Risk-Adjusted Inside Debt

74 Pages Posted: 30 Oct 2015 Last revised: 12 Sep 2017

See all articles by Zhichuan Frank Li

Zhichuan Frank Li

University of Western Ontario - Ivey School of Business

Shannon Lin

Dalhousie University - Rowe School of Business

Shuna Sun

Fudan University

Alan Tucker

Independent

Date Written: October 5, 2015

Abstract

Compensation theory holds that executive aggression is related to both the level and riskiness of inside debt. However, previous researchers only have examined the level of inside debt. We provide an inside debt metric that is conceptually superior to previously used metrics as it incorporates the riskiness of inside debt. For the overall sample, our metric provides similar fit to prior metrics but is theoretically superior. The relation between our risk-adjusted inside debt metric and corporate conservatism is modestly better for non-investment grade firms, firms experiencing credit rating downgrades, and firms with high credit risk. The results tentatively support that managers are concerned with the risk-adjusted value of their inside debt, i.e., the inside debt adjusted by its default probability and expected recovery rate. Based on our findings for U.S. firms, we expect our metric to offer more explanatory power for economies wherein inside debt is very risky.

Keywords: Corporate conservatism; inside debt; executive compensation; executive incentives

JEL Classification: G30, M52, G32

Suggested Citation

Li, Zhichuan Frank and Lin, Shannon and Sun, Shuna and Tucker, Alan, Risk-Adjusted Inside Debt (October 5, 2015). Global Finance Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2681280 or http://dx.doi.org/10.2139/ssrn.2681280

Zhichuan Frank Li

University of Western Ontario - Ivey School of Business ( email )

1151 Richmond Street North
London Ontario, Ontario N6A 3K7
Canada

Shannon Lin (Contact Author)

Dalhousie University - Rowe School of Business ( email )

6100 University Avenue
Halifax, Nova Scotia B3H 4H7
Canada

Shuna Sun

Fudan University ( email )

No.670 Guoshun Rd, Yangpu District
Shanghai, 200433
China

Alan Tucker

Independent ( email )

No Address Available
United States

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