CEO inside debt and corporate debt maturity structure

Abstract

This paper examines the relation between chief executive officer (CEO) inside debt holdings and corporate debt maturity. We provide robust evidence that inside debt has a positive effect on short-maturity debt and that this effect is concentrated in financially unconstrained firms that face lower refinancing risk. Our analysis further shows that CEO inside debt helps reduce the cost of debt financing. Overall, our results indicate that managerial holdings of inside debt facilitate access to external debt financing and reduce refinancing risk, thus incentivizing managers to use less costly shorter term debt. JEL classifications: G32, G34.Keywords: Debt maturity, short-term debt, inside debt, pension, deferred compensation. * We are grateful to two anonymous referees and the editor for their helpful comments and suggestions that have greatly improved the paper. All remaining errors are our own. IntroductionRecent research shows that a significant part of the executive compensation package comes from pension benefits and deferred compensation (e.g., Bebchuk and Jackson, 2005; Sundaram and Yermack, 2007; Wei and Yermack, 2011; Cassell et al., 2012;Anantharaman et al., 2014; Phan, 2014). These components of executive compensation resemble debt financing because they represent firms' fixed obligations to make future payments to their managers. Hence, pension benefits and deferred compensation can be referred to as "inside debt". Moreover, these components of inside debt are typically unfunded and unsecured. If the firm becomes insolvent, inside debt holders have claims equal to those of other unsecured creditors (Sundaram and Yermack, 2007;Gerakos, 2010; Cassell et al., 2012).An important feature of chief executive officer (CEO) inside debt is that it can restrain managerial risk-seeking (Edmans and Liu, 2011). Agency theory posits that shareholders, as claimants to the residual value of the firm assets, have an incentive to expropriate creditors' wealth by substituting less risky for more risky investments (Fama and Miller, 1972;Jensen and Meckling, 1976). However, the significant value of inside debt and its order of payment priority in the case of corporate insolvency help align the interests of managers and external creditors, 1 thus motivating the former to pursue less risky corporate policies. Empirical research provides some evidence in support of this argument. Consistent with the notion that inside debt strengthens manager-debtholder interest alignment, Wei and Yermack (2011) show that the disclosure of large managerial holdings of inside debt leads to value transfer 1 Bebchuk and Jackson (2005) question the effectiveness of inside debt in aligning the interests of managers and external creditors, suggesting that firms and managers can make arrangements to protect the value of inside debt from external creditors, particularly when firms become insolvent. Nevertheless, Gerakos (2010) examines the arrangements for protecting the supplemental executive retirement plans (SERPs), which make up the d...

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