A Model of Managerial Compensation, Firm Leverage and Credit Stimulus.
34 Pages Posted: 11 Dec 2017 Last revised: 19 Sep 2018
Date Written: September 2018
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
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