Accounting-based Compensation and Debt Contracts

51 Pages Posted: 22 Feb 2017 Last revised: 11 Feb 2020

See all articles by Zhi Li

Zhi Li

Chapman University - The George L. Argyros School of Business & Economics

Lingling Wang

University of Connecticut - Department of Finance

Karen H. Wruck

Ohio State University - Fisher College of Business, Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: October 3, 2019

Abstract

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

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; University of Connecticut School of Business Research Paper No. Forthcoming. Available at SSRN: https://ssrn.com/abstract=2921223 or http://dx.doi.org/10.2139/ssrn.2921223

Zhi Li

Chapman University - The George L. Argyros School of Business & Economics ( email )

333 N. Glassell
Orange, CA 92866
United States
714-6287224 (Phone)

Lingling Wang

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States

Karen H. Wruck (Contact Author)

Ohio State University - Fisher College of Business, Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-4330 (Phone)
614-292-2418 (Fax)

HOME PAGE: http://https://fisher.osu.edu/people/wruck.1

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