Tournament incentives and firm credit risk: Evidence from credit default swap referenced firms

Abstract

In this paper, we evaluate the impact of managerial tournament incentives on firm credit risk in credit default swap (CDS) referenced firms. We find that intra-firm tournament incentives are negatively related to credit risk. Our results suggest that tournament incentives reduce credit risk by alleviating the potential for underinvestment when managers are concerned about exacting empty creditors.Further, we find that tournament incentives decrease credit risk when internal governance is strong or product market competition is intense. Taken together, our results suggest that creditors perceive senior manager tournament incentives (SMTI) as a critical determinant of a firm's credit risk, particularly in settings where managerial risk aversion is high. K E Y W O R D Scredit default swaps, credit risk, internal governance quality, product market competition, tournament incentives

Industry tournament incentives and audit fees

“…On the other hand, Du, Huang, and Jain (2019) focus on CDS referenced firms and find that intra-firm tournament incentives reduce credit risk by alleviating under-investment, suggesting that creditors perceive intra-firm tournament incentives as an important determinant of a firm's risk.…”

“…Burns, Minnick, and Starks (2017) conduct a cross‐country study and support the theory that tournament structure tends to be positively related to firm value. On the other hand, Du, Huang, and Jain (2019) focus on CDS referenced firms and find that intra‐firm tournament incentives reduce credit risk by alleviating under‐investment, suggesting that creditors perceive intra‐firm tournament incentives as an important determinant of a firm's risk.…”

Industry tournament incentives and stock price crash risk

“…Delta ( vega ) is the increase in the CEO's stock option holdings in response to a 1% (0.01 unit) increase in stock price (stock return volatility). Prior research finds that higher internal tournament incentives encourages greater effort and risk‐taking among lower‐ranked executives (e.g., Du et al., 2019; Kale, Reis, & Venkateswaran, 2009; Kini & Williams, 2012) and higher vega encourages CEO risk‐taking (e.g., Armstong, Larcker, Ormazabal, & Taylor, 2013; Brockman, Martin, & Unlu, 2010; Coles, Daniel, & Naveen, 2006). Further, Kim et al.…”

“…Subsequent work on crash risk has focused on mechanisms conducive to concealing information such as earnings management (Chen, Kim, & Yao, 2017) and tax avoidance strategies (Kim et al., 2011a). Other research of crash risk has emphasized mechanisms that can mitigate managers’ ability to conceal negative information such as accounting conservatism (Kim & Zhang, 2016), corporate social responsibility (Kim, Li, & Li, 2014), internal tournament incentives of lower‐ranked executives (Du, Huang, & Jain, 2019; Jia, 2018), managerial traits conducive to concealing negative information such as overconfidence (Kim, Wang, & Zhang, 2016), and regulatory oversight (Kubick & Lockhart, 2016). Our paper proposes and tests a new explanation of the causes of stock price crashes, and is one of the first studies to analyze the effect of incentives sourced external to the firm.…”

Measuring credit risk in family firms

“…Market prices can be taken directly as measures of credit risk, as has traditionally been the case with bond spreads, which are the difference between the corporate bond yield and the risk-free rate, whereby the wider the bond spread, the higher the company’s probability of default. More recently, the empirical literature on credit risk has focused on CDS spreads (e.g., Das et al, 2009; Du et al, 2019; Ericsson et al, 2009; Forte & Peña, 2009). However, since this information may not be available for all firms, especially small ones, there is danger of obtaining a size-biased sample.…”