Creditor Influence and CEO Compensation: Evidence from Debt Covenant Violations

54 Pages Posted: 8 Feb 2018 Last revised: 20 Feb 2018

See all articles by Steven Balsam

Steven Balsam

Temple University - Department of Accounting

Yuqi Gu

Western New England University

Connie X. Mao

Temple University - Fox School of Business and Management; Temple University - Department of Finance

Date Written: November 30, 2017

Abstract

Debt covenant violation alters firm dynamics, providing creditors with the right to demand repayment, and via that right, influence firm actions. We provide evidence consistent with creditors employing that channel to influence CEO compensation. Using regression discontinuity analysis, we show that in the year after a covenant violation, after controlling for other factors, CEO compensation is 8.5% lower and the CEO’s compensation package contains fewer risk-taking incentives, as the vega associated with newly granted options is 26% lower. These changes are more pronounced when the creditor has greater influence, such as when the borrower and creditor have a prior lending relationship, the creditor is a highly reputable bank, or when the borrower is financially weaker. We also find that CEOs’ risk-taking incentives decrease with the number of debt covenants, in particular, the number of performance debt covenants being breached.

Keywords: Executive compensation, covenant violation, creditor influence, corporate governance, debt governance

JEL Classification: G21, G34

Suggested Citation

Balsam, Steven and Gu, Yuqi and Mao, Connie X., Creditor Influence and CEO Compensation: Evidence from Debt Covenant Violations (November 30, 2017). The Accounting Review, Forthcoming; Fox School of Business Research Paper No. 18-006. Available at SSRN: https://ssrn.com/abstract=3113768 or http://dx.doi.org/10.2139/ssrn.3113768

Steven Balsam

Temple University - Department of Accounting ( email )

306 Speakman Hall
Philadelphia, PA 19122
United States
215-204-5574 (Phone)
215-204-5587 (Fax)

HOME PAGE: http://www.sbm.temple.edu/~drb/

Yuqi Gu (Contact Author)

Western New England University ( email )

1215 Wilbraham Rd
Springfield, MA 01119
United States
413-796-2755 (Phone)

Connie X. Mao

Temple University - Fox School of Business and Management ( email )

416 Alter Hall
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

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