Creditor Control Rights and Executive Bonus Plans

89 Pages Posted: 19 Jan 2022 Last revised: 8 Jan 2024

See all articles by Chris Armstrong

Chris Armstrong

Stanford Graduate School of Business

John D. Kepler

Stanford Graduate School of Business

Chongho Kim

Seoul National University

David Tsui

University of Southern California - Marshall School of Business

Date Written: January 2, 2024

Abstract

We study the extent to which creditors shape the executive bonus plans of their financially distressed borrowers. Financial distress can exacerbate agency conflicts between creditors and borrowers as concerns with underinvestment become more acute due to managerial myopia and debt overhang. Consequently, we expect creditors to exert their influence to ensure that these managers’ incentive-compensation plans encourage longer-term investments and directly reward outcomes that benefit creditors without exposing managers to unnecessary risk. We argue that bonus plans are an especially important way to provide these incentives because their flexibility allows creditors to more precisely (vis-à-vis equity) target specific investment objectives. We find that borrowers’ bonus plans tend to have longer horizons and more convex payouts following covenant violations, especially for those in poor financial health and where bonus plans are most likely to be effective at addressing financial distress-related agency conflicts. Our evidence suggests that creditors protect their interests by exercising their control rights to shape the incentive-compensation plans of their borrowers.

Keywords: bonus plans, control rights, creditors, executive compensation, managerial incentives

JEL Classification: G34, J3, M12

Suggested Citation

Armstrong, Chris S. and Kepler, John and Kim, Chongho and Tsui, David, Creditor Control Rights and Executive Bonus Plans (January 2, 2024). Available at SSRN: https://ssrn.com/abstract=3975781 or http://dx.doi.org/10.2139/ssrn.3975781

Chris S. Armstrong

Stanford Graduate School of Business ( email )

655 Knight Way
E316
Stanford, CA 94305-5015
United States

HOME PAGE: http://https://www.gsb.stanford.edu/faculty-research/faculty/christopher-s-armstrong

John Kepler (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Chongho Kim

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

David Tsui

University of Southern California - Marshall School of Business ( email )

3660 Trousdale Parkway
Los Angeles, CA 90089
United States

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