Creditor Influence and CEO Compensation: Evidence from Debt Covenant Violations
54 Pages Posted: 8 Feb 2018 Last revised: 20 Feb 2018
Date Written: November 30, 2017
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: Suggested Citation