CEO contractual protection and debt contracting

Abstract

Chief Executive Officer (CEO) contractual protection, in the forms of CEO employment agreements and CEO severance pay agreements, is prevalent among S&P 1500 firms. While prior research has examined the impact of these agreements on corporate decisions from shareholders’ perspective, there is little research on the impact from debt holders’ perspective. We find that, compared with other loans, loans issued by firms with CEO contractual protection on average contain more performance covenants and performance‐pricing provisions. This effect increases with CEOs’ risk‐taking incentives and opportunities, but it decreases with CEOs’ preference for and opportunity of enjoying a quiet life. Furthermore, for loans issued by firms with CEO contractual protection, debt holders include stricter covenants, charge a higher interest rate and use a more diffuse syndicate structure. Collectively, these results shed light on the impact of CEO contractual protection on debt contracting.