Creditor Control Rights and Executive Bonus Plans
53 Pages Posted: 19 Jan 2022 Last revised: 8 Aug 2022
Date Written: August 5, 2022
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: Suggested Citation