Payday Before Mayday: CEO Compensation Contracting for Distressed Firms

62 Pages Posted: 1 Apr 2020 Last revised: 29 Apr 2020

See all articles by Mary Ellen Carter

Mary Ellen Carter

Boston College - Department of Accounting

Edith S. Hotchkiss

Boston College - Carroll School of Management

Mahdi Mohseni

Tehran Institute of Advanced Studies

Date Written: April 28, 2020

Abstract

Using a sample of more than 1,500 US public firms in the period 1998-2016, we examine how firms endogenously adjust CEO compensation contracts when they become financially distressed. The link between compensation and equity-based measures of firm performance is positive and strong prior to distress, but declines and becomes insignificant when firms are in distress. However, the relationship of pay to cash flow performance remains positive for distressed firms. Directly examining the ex-ante incentives provided in contracts rather than ex-post payouts, we provide evidence that firms respond to the onset of distress by providing incentives oriented toward improving cash flows. Specifically, distressed firms increase their use of performance-based pay but re-orient performance metrics towards cash flow related measures and set performance targets farther above prior performance. Further, these firms reduce equity-oriented incentives by increasing the proportion of expected performance-based compensation to be paid in cash rather than stock. These changes are economically most important for firms with the greatest need to replace out-of-the-money equity-based incentives, and in the years immediately preceding an actual default or bankruptcy. Overall, our findings are consistent with agency theory predicting that reduced incentives require contract realignment of managers with relevant stakeholders of distressed firms.

Keywords: CEO Compensation, Managerial Incentives, Contracting, Financial Distress, Default, Creditors, Pay-performance Sensitivity

JEL Classification: G33, G34, J33, M12, M52, M41

Suggested Citation

Carter, Mary Ellen and Hotchkiss, Edith S. and Mohseni, Mahdi, Payday Before Mayday: CEO Compensation Contracting for Distressed Firms (April 28, 2020). Available at SSRN: https://ssrn.com/abstract=3211591 or http://dx.doi.org/10.2139/ssrn.3211591

Mary Ellen Carter

Boston College - Department of Accounting ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Edith S. Hotchkiss (Contact Author)

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Department of Finance Fulton Hall, Room 330
Chestnut Hill, MA 02467
United States
617-552-3240 (Phone)
617-552-0431 (Fax)

Mahdi Mohseni

Tehran Institute of Advanced Studies ( email )

Tehran, NJ
Iran
8572255120 (Phone)
08619 (Fax)

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