CEO inside debt and the acquisition of private targets

Abstract

We find a strong positive association between the inside debt holdings (pension benefits and deferred compensation) of CEOs and announcement‐period abnormal returns (CARs) of acquiring firms bidding for private targets. In addition, gains to acquirers with high inside debt persist for at least 3 years post‐acquisition. Further analyses suggest that our results are largely driven by firms with lower levels of manager‐shareholder agency conflicts as proxied by higher transparency in firm activities, presence of a less powerful CEO, or presence of stronger monitoring. Our results are robust to an array of sensitivity tests.

The role of inside debt in banks’ M&A choices: wealth expropriation or conflict resolution?

“…Drawing upon the existing literature, our study presents two competing perspectives: the “wealth expropriation argument” and the “conflict resolution argument”. Aligning with the latter perspective, our study supports the idea that inside debt positively impacts shareholder value (Borah et al , 2020; Bhabra et al , 2022).…”

“…The conflict resolution perspective posits that inside debt favors shareholders (Kane, 2002). For instance, Bhabra et al (2022) report a significant positive correlation between the inside debt holdings and announcement period abnormal returns (CARs) of acquiring firms engaging in bids for private targets. Additionally, Borah et al (2020) find a positive association between CEO inside debt and the propensity and size of dividend payouts.…”

“…By intensifying monitoring, inside debt may discourage CEOs from seeking personal gains through M&As, thereby safeguarding shareholder value. Consequently, inside debt could foster congruent objectives between shareholders and debtholders in M&As (Bhabra et al , 2022), serving as a conflict resolution mechanism that ultimately enhances shareholder value.…”

CEO inside debt holdings and trade credit

“…In this study, we focus on CIDH since the CEO is the highest ranked executive in a company, and is primarily responsible for formulating key corporate strategy, policies and decisions, and for managing overall business operations and resources (Cassell et al, 2012). The motivation for this study stems from recent evidence that inside debt holdings are sizeable, and constitute a major component of executive compensation (Cassell et al, 2012;Anantharaman et al, 2014;Phan, 2014;Bhabra et al, 2021;. For instance, Wei and Yermack (2011) report an average CEO debt-to-equity ratio of 0.22 in 2006, while Kim et al (2020) report a ratio of 0.26 during the 2006-2015 period.…”

Asset redeployability and CEO inside debt

“…It is therefore not surprising that CEOs with high inside debt exhibit excessive caution in investment decisions (see, e.g., Cassell et al, 2012; Gerakos, 2010; Sundaram & Yermack, 2007) which could at times even harm long‐term sustainability (Hossain et al, 2023). Other evidence that links CEO risk‐aversion (arising out of inside debt) to corporate policy choices include larger cash holdings in firms led by CEOs with high inside debt (Liu et al, 2014), less reliance on trade credit (Hasan et al, 2022), firms enjoying a lower cost of debt along with fewer restrictive covenants (see, e.g., Anantharaman et al, 2014; Chava et al, 2010), better credit ratings (Hasan et al, 2023), a lower incidence of tax sheltering (Chi et al, 2017), lower payouts (Eisdorfer et al, 2015), higher liquidation values (Chen et al, 2010) and better acquisition deals signified by higher post‐acquisition returns (Bhabra et al, 2022; Phan, 2014). Collectively, extant evidence suggests that higher CEO debt incentives are likely to incentivise CEOs to adopt cautious and prudent investment decisions that are aimed towards limiting their risk exposure.…”