Does Credit Default Swap Initiation Affect Executive Compensation?

40 Pages Posted: 24 Sep 2017 Last revised: 16 Oct 2017

See all articles by Yi Dong

Yi Dong

Shanghai University of Finance and Economics

Ruirui Fang

Xi'an Jiaotong University (XJTU) - School of Management, Students

Nan Hu

Stevens Institute of Technology - School of Business

Date Written: November 11, 2016

Abstract

In this study, we examine whether the initiation of credit default swaps affects the reference entity’s executive compensation design. With both human capital and financial capital highly associated with the firm’s bankruptcy risk, risk averse managers prefer cash compensation over option compensation to hedge their individual exposure to the firm’s bankruptcy risk. Consistent with this notion, we find a significant increase (decrease) in the proportion of cash (option) compensation around the initiation of CDS trading. Such a finding survives a matching procedure, a falsification test employing a different CDS initiation time and an instrumental variable approach to address the endogeneity. Further, the effect of CDS trading on firms’ compensation design is more pronounced for firms with higher distress risk and for managers who are more powerful.

Keywords: credit default swap, executive compensation, human capital, financial distress

JEL Classification: G32, G33, M12

Suggested Citation

Dong, Yi and Fang, Ruirui and Hu, Nan, Does Credit Default Swap Initiation Affect Executive Compensation? (November 11, 2016). Available at SSRN: https://ssrn.com/abstract=3042339 or http://dx.doi.org/10.2139/ssrn.3042339

Yi Dong

Shanghai University of Finance and Economics ( email )

Shanghai, Shanghai 200433
China

Ruirui Fang

Xi'an Jiaotong University (XJTU) - School of Management, Students ( email )

Xi'an
China

Nan Hu (Contact Author)

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

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