Inside Debt and the Design of Corporate Debt Contracts

Abstract

T heory posits that managerial holdings of debt ("inside debt") align managers' incentives with those of outside debtholders. Executive pensions, consisting of rank-and-file (RAF) plans and supplemental executive retirement plans (SERPs), and other deferred compensation (ODC) have debt-like payoffs, and could therefore function as inside debt. However, whereas SERPs are often unfunded and unsecured, RAF plans are funded and secured to some extent, and ODC may be invested in equity and withdrawn flexibly before retirement. Special arrangements in executive debt-like compensation could hence weaken or even nullify any incentive-alignment effect. We find that higher CEO debt-like compensation leads to lower promised yield and fewer covenants in a sample of loans originated in 2006-2008. This effect is driven entirely by benefits accrued under SERPs, consistent with SERPs more closely resembling risky corporate debt; balances accrued under RAF and ODC plans do not provide similar effects. Furthermore, promised yields are lower when debt-like compensation claims can be withdrawn only after outside debt claims are expected to settle. Our findings persist after accounting for endogeneity using state personal income tax rates as an instrument for CEOs' willingness to defer compensation. Overall, the evidence suggests that executive debt-like compensation is only effective at resolving stockholderdebtholder conflicts when its payoffs are truly debt-like and that lenders' perceptions are affected not only by the magnitude of debt-like compensation but also by its seniority.Data, as supplemental material, are available at http://dx.

The Effect of Corporate Social Responsibility and the Executive Compensation on Implicit Cost of Equity: Evidence from French ESG Data

“…For instance, the compensation system allows the company's employees to share the advantages through appreciation and may encourage retention, particularly if there are stock options. Previous studies show that debt-like compensation reduces the value of debt [26].…”

“…Executive compensation based on SD has been employed by many public and a few private companies to scale back the cost of equity capital [26][27][28]. For instance, Li and Liu [29] suggest that the adoption of executive compensation schemes is on behalf of shareholders and not creditors.…”

The Role of Institutional Investors in the Sustainable CEO Compensation Structure

“…Wang et al [4] found that managers with higher inside debt holdings adopt more conservative accounting policies, whereas Cassell et al [2] found that these managers attempt to reduce firms' risk by seeking a higher degree of diversification and liquidity and by investing less in research and development. Moreover, Wei and Yermack [6] and Anantharaman, Fang, and Gong [33] showed a lower cost of debt for firms with higher CEO inside debt holdings. Lastly, Phan [3] demonstrated a negative relationship between CEO inside debt holdings and mergers and acquisition activities.…”

Contingent convertible bonds and their impact on risk-taking of managers

“…Depending on the special properties of the pension plans, e.g. if pensions are senior to bonds, pensions may not be counted as debt and even lead to an inverse incentive scheme (Anantharaman et al, 2013). Nevertheless, all existing publications on the impact of inside debt on risk-taking used pensions or deferred compensation as a proxy for inside debt.…”