Credit Default Swaps, Agency Problems, and Management Incentives
42 Pages Posted: 21 Nov 2017 Last revised: 5 Jun 2018
Date Written: November 17, 2017
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: Suggested Citation