Accounting-based Compensation and Debt Contracts

We examine how accounting-based compensation plans influence a firm’s contracts with its creditors. After granting long-term accounting-based compensation plans (LTAPs) to CEOs, firms pay lower spreads and have fewer restrictive covenants in new bank loans. Mechanisms leading to lower borrowing cost include improvements in debt repayment ability, reduced shareholder-debtholder conflicts, and reduced risk-taking incentives. Creditors view LTAPs as a substitute for monitoring, adjust covenant design based on LTAP features, and value plans with concave performance-payout functions and reasonable performance targets. A firm’s credit rating improves and CDS spread declines after LTAP grants, suggesting that LTAPs help reduce firms’ credit risk.

Keywords: Accounting-based Compensation, Debt Contracts and Covenants, Executive Compensation, Lender Monitoring, Incentive Alignment

JEL Classification: M52; M41; J33; G30

Suggested Citation: Suggested Citation

Li, Zhi and Wang, Lingling and Wruck, Karen H., Accounting-based Compensation and Debt Contracts (October 3, 2019). Fisher College of Business Working Paper No. 2017-03-007, Charles A. Dice Center Working Paper No. 2017-07, University of Connecticut School of Business Research Paper No. 20-01, Available at SSRN: https://ssrn.com/abstract=2921223 or http://dx.doi.org/10.2139/ssrn.2921223