Creditor Control Rights and Executive Bonus Plans

53 Pages Posted: 19 Jan 2022 Last revised: 8 Aug 2022

See all articles by Chris Armstrong

Chris Armstrong

Stanford Graduate School of Business

John D. Kepler

Stanford Graduate School of Business

Chongho Kim

New York University

David Tsui

University of Southern California - Marshall School of Business

Date Written: August 5, 2022

Abstract

We study when and how creditors exercise their control rights to shape their borrowers’ executive compensation plans. Managers may underinvest in potentially profitable projects because of agency conflicts that result from differences between their time horizons and risk-taking preferences and those of their creditors. Consequently, we expect creditors to exert their control to ensure that these managers’ incentive-compensation plans encourage both longer-term and riskier investments with more direct rewards tied to improved performance. We also argue that bonus plans are an especially important component of managers’ incentive-compensation in these situations because their flexibility (e.g., potentially non-linear and non-monotonic payoffs) allows creditors to target specific investment objectives. We find that borrowers’ bonus plans tend to have longer horizons and more convex payouts when their creditors acquire increased control—namely following covenant violations. Our evidence suggests that lenders protect their interests by exercising their control rights to shape the 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 (August 5, 2022). 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

New York University ( email )

40 West 4th Street
Suite 10-180
New York, NY 10012
United States
5129987313 (Phone)

David Tsui

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

3660 Trousdale Parkway
Los Angeles, CA 90089
United States

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