Accounting-based Compensation and Debt Contracts
Charles A. Dice Center Working Paper No. 2017-07
51 Pages Posted: 22 Feb 2017 Last revised: 27 Mar 2020
Date Written: October 3, 2019
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