Performance-Based Vesting Compensation and Debt Contracting

72 Pages Posted: 6 Aug 2019 Last revised: 20 Oct 2019

See all articles by Tao-Hsien Dolly King

Tao-Hsien Dolly King

University of North Carolina (UNC) at Charlotte - Department of Finance

Chen Shen

University of North Carolina (UNC) at Charlotte - Department of Finance

Date Written: July 31, 2019

Abstract

This paper examines whether the risk-taking incentives induced by performance-based vesting (p-v) compensation influence bank loan contracting and credit ratings. Consistent with our risk-shifting hypothesis, we find that the p-v based compensation, as measured by the proportion of grant date fair value of p-v based compensation to total compensation, significantly increases loan spreads and encourages more no price protection such as performance pricing and secured by collateral. We also find that p-v based compensation increases loan maturity while reduces the covenant strictness as a trade-off. Next, we subcategorize p-v based compensation by its performance type, instrument use, and performance metric. Consistent with previous literature, we find that the loan spread is negatively (positively) associated with accounting (stock price)-based compensation. We also find a tradeoff effect between the price- and non-price features of bank loan contracts such as performance pricing and restrictive covenants, as the positive effect of incentives induced by p-v based compensation on the cost of bank loans is offset by more restrictive features in loan contracts. Next, we perform the analysis using the Chief Financial Officer (CFO)’s p-v compensation and obtain the similar results. Last, we perform the analysis to determine the effects of p-v based compensation on firms’ credit rating. We find the incentive induced by p-v based compensation carry out to the credit rating market by reducing the firm’s credit rating.

Keywords: performance-based vesting compensation, bank loans, cost of debt, executive compensation, CEOs, risk-taking

JEL Classification: M52, M55, J33, G34, G32, G13, M41

Suggested Citation

King, Tao-Hsien Dolly and Shen, Chen, Performance-Based Vesting Compensation and Debt Contracting (July 31, 2019). Available at SSRN: https://ssrn.com/abstract=3430830 or http://dx.doi.org/10.2139/ssrn.3430830

Tao-Hsien Dolly King

University of North Carolina (UNC) at Charlotte - Department of Finance ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
704-687-7652 (Phone)
704-687-6987 (Fax)

Chen Shen (Contact Author)

University of North Carolina (UNC) at Charlotte - Department of Finance ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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