Executive Equity Risk-Taking Incentives and Firm's Choice of Debt Structure
51 Pages Posted: 19 Oct 2017 Last revised: 21 Jul 2021
Date Written: July 21, 2021
We examine how executive equity risk-taking incentives affect firms’ choice of debt structure. Using a longitudinal sample of U.S. firms, we document that when executive compensation is more sensitive to stock volatility (i.e., has higher vega), firms reduce their reliance on bank debt financing. We utilize the passage of the Financial Accounting Standard (FAS) 123R option-expensing regulation as an exogenous shock to management option compensation to account for potential endogeneity. In cross-sectional analyses, we find that the documented effect of vega is amplified among firms with higher growth opportunities and more opaque financial information; we also find vega’s effect is mitigated in firms with limited abilities to tap into public debt market. Supplemental analyses suggest that firms with higher vega face more stringent bank loan covenants. We conclude that, by encouraging risk-taking, higher vega reduces firms’ reliance on bank debt financing in order to avoid more stringent bank monitoring.
Keywords: Executive equity incentives; Vega; Bank debt; Debt structure
JEL Classification: G21, G32, M41, M42
Suggested Citation: Suggested Citation