CEO Compensation in Financially Distressed Firms: An Empirical Analysis

Abstract

This paper studies senior management compensation policy in 77 publicly traded firms that filed for bankruptcy or privately restructured their debt during 1981 to 1987. Almost one‐third of all CEOs are replaced, and those who keep their jobs often experience large salary and bonus reductions. Newly appointed CEOs with ties to previous management are typically paid 35% less than the CEOs they replace. In contrast, outside replacement CEOs are typically paid 36% more than their predecessors, and are often compensated with stock options. On average, CEO wealth is significantly related to shareholder wealth after firms renegotiate their debt contracts. However, managers' compensation is sometimes explicitly tied to the value of creditors' claims.

Governance in Financial Distress and Bankruptcy

“…Using a contingent-claims framework, Black and Cox (1976) and Geske (1977) value coupon-paying debt and solve for the equity holders' optimal default policy when asset sales are restricted. Fischer, Heinkel, and Zechner (1989), Leland (1994), Leland and Toft (1996), Leland (1998), andGoldstein, Ju, andLeland 6 (2000) examine default policy in the problem of optimal capital structure. In practice, since the optimal filing point is unobservable, we cannot readily determine whether filings are in fact delayed to the benefit of equity holders.…”

Leverage, volatility and executive stock options

“…(7) Salary reduction for CEOs in financially distressed firms is often observed in practice (Gilson and Vetsuypens, 1993).…”

Not So Lucky Any More: CEO Compensation in Financially Distressed Firms

“…Recent studies document vast evidence of such behavior among U.S. firms. 16 We conjecture that, relative to mangers of the control firms, mangers of the distressed firms engage in opportunistic timing of option grants in a greater or similar extent before the year of distress, and that managers (or the board of directors) significantly cut back or totally abandon engaging in such activity after the firm goes into distress, as the "outrage" constraint placed by the firm's various stake-holders tightens when and after a firm falls into financial distress.…”

“…A closely related study is the one by Gilson and Vetsuypens (1993), who examine executive compensation in financially distressed firms during the 1980s. A key difference between our study and theirs is that Gilson and Vetsuypens (1993) just analyze compensation policies of distressed firms before and after financial distress but do not construct a control group to characterize the overall changes in compensation practices that occur during their analysis period; in contrast, we do.…”

“…A key difference between our study and theirs is that Gilson and Vetsuypens (1993) just analyze compensation policies of distressed firms before and after financial distress but do not construct a control group to characterize the overall changes in compensation practices that occur during their analysis period; in contrast, we do. Moreover, there have been significant changes in the compensation practices of U.S. public companies, shifting in focus away from bonus-based pay in the 1980s to equity-based pay as of the early 1990s.…”