Credit Default Swaps, Agency Problems, and Management Incentives

42 Pages Posted: 21 Nov 2017 Last revised: 5 Jun 2018

See all articles by Jongsub Lee

Jongsub Lee

University of Florida - Warrington College of Business Administration

Junho Oh

University of Florida, Warrington College of Business Administration, Students

David Yermack

New York University (NYU) - Stern School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: November 17, 2017

Abstract

We show in a theoretical model that credit default swaps induce managerial agency problems through two channels: reducing the opportunity for managers to transfer value to equityholders from creditors via strategic default, and reducing the intensity of monitoring by creditors, which leads to greater CEO diversion of assets as perquisites. We further show that boards can use compensation awards that increase managerial performance incentives (delta) and risk-taking incentives (vega) in order to mitigate these two agency problems, with increases in managerial vega being particularly useful to alleviate the strategic default-related agency problem. We study equity compensation awards to CEOs of S&P 1500 companies during 2001-2015 and find that they occur in patterns consistent with these predictions.

Keywords: credit default swaps, agency, CEO compensation

JEL Classification: G30, G33, G34, J33, M52

Suggested Citation

Lee, Jongsub and Oh, Junho and Yermack, David, Credit Default Swaps, Agency Problems, and Management Incentives (November 17, 2017). Available at SSRN: https://ssrn.com/abstract=3073488 or http://dx.doi.org/10.2139/ssrn.3073488

Jongsub Lee

University of Florida - Warrington College of Business Administration ( email )

Department of Finance Insurance & Real Estate
P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-273-4966 (Phone)
352-392-0301 (Fax)

Junho Oh

University of Florida, Warrington College of Business Administration, Students ( email )

Gainesville, FL
United States

David Yermack (Contact Author)

New York University (NYU) - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY 10012-1126
United States
212-998-0357 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~dyermack

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