CEO's Inside Debt and Dynamics of Capital Structure

Financial Management, Forthcoming

53 Pages Posted: 20 Jan 2016 Last revised: 22 Dec 2016

See all articles by Eric R. Brisker

Eric R. Brisker

The University of Akron

Wei Wang

Cleveland State University

Date Written: August 17, 2016

Abstract

Debt-type compensation (i.e., inside debt) exacerbates the divergence in risk preference between the CEO and shareholders that in turn affects the firm’s capital structure decisions. An excessively risk-averse CEO uses debt that falls short of the shareholders’ desired level, and is eager to lower the debt ratio when the firm is over-levered but reluctant to enhance the debt ratio when the firm is under-levered. We find that higher CEO inside debt ratio is associated with lower firm debt ratio and faster (slower) leverage adjustments toward the shareholders’ desired level for over-levered (under-levered) firms. The CEO inside debt ratio most conducive to optimal capital structure dynamics is around 10 percent of the firm’s market debt ratio.

Keywords: inside debt, capital structure, shareholders’ desired leverage, speed of adjustment (SOA), managerial conservatism, risk-shifting

JEL Classification: G30, G32, G34

Suggested Citation

Brisker, Eric R. and Wang, Wei, CEO's Inside Debt and Dynamics of Capital Structure (August 17, 2016). Financial Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2718498 or http://dx.doi.org/10.2139/ssrn.2718498

Eric R. Brisker

The University of Akron ( email )

Akron, OH 44325-4803
United States

Wei Wang (Contact Author)

Cleveland State University ( email )

Cleveland, OH 44115
United States

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