A Model of Managerial Compensation, Firm Leverage and Credit Stimulus.

34 Pages Posted: 11 Dec 2017 Last revised: 19 Sep 2018

See all articles by Sandeep Dahiya

Sandeep Dahiya

Georgetown University - Department of Finance

Lei Ge

Georgetown University

Pedro Gete

IE Business School; IE University

Date Written: September 2018

Abstract

We study a model in which leverage and compensation are both choice variables for the firm and borrowing spreads are endogenous. First, we analyze the correlation between leverage and variable compensation. We show that allowing for both endogenous compensation and leverage fully rationalizes the conflicting findings of the empirical literature. We uncover a new channel of complementarity between effort and leverage that induces a correlation sign opposite to what current theoretical models predict. Second, we study the dynamics of leverage and compensation design after a credit stimulus. We derive a set of new empirical predictions. For outward-shifts in credit supply, greater CEO pay-performance sensitivity implies higher leverage growth. Moreover, variable compensation increases after the credit stimulus, especially for firms with low idiosyncratic risk.

Keywords: Credit Policies, Credit Spreads, Executive Ownership, Fixed Compensation, Leverage

JEL Classification: E44, G28, G30, G32, G34

Suggested Citation

Dahiya, Sandeep and Ge, Lei and Gete, Pedro, A Model of Managerial Compensation, Firm Leverage and Credit Stimulus. (September 2018). Georgetown McDonough School of Business Research Paper No. 3083563. Available at SSRN: https://ssrn.com/abstract=3083563 or http://dx.doi.org/10.2139/ssrn.3083563

Sandeep Dahiya

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-3832 (Phone)

Lei Ge

Georgetown University ( email )

Washington, DC
United States

Pedro Gete (Contact Author)

IE Business School

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

IE University ( email )

Calle Pedro de Valdivia 21
Madrid, Madrid 28006
Spain

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