The following post comes to us from Divya Anantharaman of the Accounting Department at Rutgers University, Vivian Fang of the Accounting Department at Rutgers University, and Guojin Gong of the Accounting Department at Pennsylvania State University.
In the paper, Inside Debt and the Design of Corporate Contract, which was recently made publicly available on SSRN, we investigate whether debtholders recognize the incentive effects of executive debt-like compensation when contracting with the firm. Top executives in the United States are commonly compensated with both equity and debt. While prior research has examined the incentive effects of equity-based compensation extensively, most academic work has ignored the incentive effects of debt-like compensation. The greater the ratio of CEO debt-to-equity compensation to corporate leverage, the more aligned the CEO’s interests should be with debtholders vis-à-vis stockholders. If debtholders recognize these implications, we expect firms with higher CEO relative leverage to have lower cost of debt and fewer covenants restricting managers’ activities after debt issuance.