Executive Debt-Like Compensation

Chapter

Abstract

While executive compensation in the United States is believed to consist primarily of cash- and equity-based components, a nascent literature argues that compensation accrued by executives under pension and other deferred compensation (DC) plans has debt-like payoffs, and could function as “inside debt”. Inside debt holdings are predicted to counteract the risk-taking incentives created by inside equity holdings, and align top managers closer to outside debtholders vis-à-vis equityholders. Recent empirical studies suggest that pension and DC plan balances serve the role of inside debt to some extent, and are effective at mitigating equityholder-debtholder conflicts in leveraged firms. These findings not only change our understanding of the composition of top executive compensation, but also have implications for the recent debate on reforming executive compensation to mitigate excessive risk-taking by top executives.

References

  1. Ahmed, A., Billings, B., Morton, R. M., & Stanford-Harris, M. (2002). The role of accounting conservatism in mitigating bondholder-shareholder conflicts over dividend policy and in reducing debt costs. The Accounting Review, 77(4), 867–890.CrossRefGoogle Scholar
  2. Anantharaman, D., Fang, V. W., & Gong, G. (2011). Executive debt-like compensation and the design of corporate loan contracts. Rutgers University, University of Minnesota and The Pennsylvania State University (unpublished manuscript).Google Scholar
  3. Bebchuk, L. A., & Fried, J. M. (2004). Stealth compensation via retirement benefits. Berkeley Business Law Journal, 291(1) 291–326.Google Scholar
  4. Bebchuk, L. A., & Jackson, R. J. (2005). Executive pensions. Journal of Corporation Law, 30, 823–855.Google Scholar
  5. Begley, J., & Feltham, G. A. (1999). An empirical examination of the relation between debt contracts and management incentives. Journal of Accounting and Economics, 27, 229–259.CrossRefGoogle Scholar
  6. Bolton, P., Mehran, H., & Shapiro, J. (2010). Executive compensation and risk taking. Federal Reserve Bank of New York Staff Reports.Google Scholar
  7. Brockman, P., Martin, X., & Unlu, E. (2010). Executive compensation and the maturity structure of corporate debt. The Journal of Finance, 65(3), 1123–1161.CrossRefGoogle Scholar
  8. Cadman, B., & Vincent, L. (2011). The role of defined benefit pension plans in executive compensation, University of Utah and Northwestern University (unpublished manuscript).Google Scholar
  9. Cassell, C., Huang, S., Sanchez, J. M., & Stuart, M. D. (2011). Seeking safety: The relation between CEO inside debt holdings and the riskiness of firm investment and financial policies. Journal of Financial Economics, 103, 588–610.CrossRefGoogle Scholar
  10. Cen, W. (2011). The determinants of CEO inside debt and its components. Unpublished dissertation, Cornell University.Google Scholar
  11. Chava, S., Kumar, P., & Warga, A. (2010). Managerial agency and bond covenants. Review of Financial Studies, 23, 1120–1148.CrossRefGoogle Scholar
  12. Chen, F., Dou, Y., & Wang, X. (2010). Executive inside debt holdings and creditors’ demand for pricing and non-pricing protections. University of Toronto, University of Toronto and University of Hong Kong (unpublished manuscript).Google Scholar
  13. Clark Consulting. (2009). A survey of current trends. Executive Benefits Surveys (14th Ed).Google Scholar
  14. Coles, J. L., Daniel, N. D., & Naveen, L. (2006). Managerial incentives and risk-taking. Journal of Financial Economics, 79, 431–468.CrossRefGoogle Scholar
  15. Dewatripont, M., & Tirole, J. (1994). A theory of debt and equity: Diversity of securities and manager shareholder congruence. Quarterly Journal of Economics, 109, 1027–1054.CrossRefGoogle Scholar
  16. Edmans, A., & Gabaix, X. (2009). Is CEO pay really inefficient? A survey of new optimal contracting theories. European Financial Management, 15(3), 486–496.CrossRefGoogle Scholar
  17. Edmans, A., & Liu, Q. (2011). Inside debt. Review of Finance, 15, 75–102.CrossRefGoogle Scholar
  18. French, K. R., Baily, M. N., Campbell, J. Y., Cochrane, J. H., Diamond, D. W., Duffie, D., Kashyap, A. K., Mishkin, F. S., Rajan, R. G., Sharfstein, D. S., Schiller, R. J., Shin, H. S., Slaughter, M. J., Stein, J. C., & Stulz, R. M. (2011). The Squam Lake report: Fixing the financial system. Princeton/Oxford, United Kingdom: Princeton University Press.Google Scholar
  19. Gerakos, J. (2007). CEO pensions: Disclosure, managerial power and optimal contracting, University of Chicago (unpublished manuscript).Google Scholar
  20. Gustman, A., Mitchell, O., & Steinmeier, T. (1994). The role of pensions in the labor market: A survey of the literature. Industrial and Labor Relations Review, 47(3), 417–438.CrossRefGoogle Scholar
  21. Hirshleifer, D., & Thakor, A. (1992). Managerial conservatism, project choice, and debt. The Review of Financial Studies, 5(3), 437–470.CrossRefGoogle Scholar
  22. Ippolito, R. A. (1985a). The labor contract and true economic pension liabilities. American Economic Review, 75(5), 1031–1043.Google Scholar
  23. Ippolito, R. A. (1985b). The economic function of underfunded pension plans. Journal of Law and Economics, 28(3), 611–651.CrossRefGoogle Scholar
  24. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. The Journal of Financial Economics, 3(4), 305–360.CrossRefGoogle Scholar
  25. John, K., & John, T. (1993). Top management compensation and capital structure. The Journal of Finance, 48(3), 949–974.CrossRefGoogle Scholar
  26. Kalyta, P. (2009). Compensation transparency and managerial opportunism: A study of supplemental retirement plans. Strategic Management Journal, 30, 405–423.CrossRefGoogle Scholar
  27. Knopf, J., Nam, J., & Thornton, J. (2002). The price and volatility sensitivities of managerial stock option portfolios and corporate hedging. The Journal of Finance, 57, 801–813.CrossRefGoogle Scholar
  28. Lee, G., & Tang, H. (2010). CEO pension and deferred compensation. Seton Hall University (unpublished manuscript).Google Scholar
  29. Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5, 147–175.CrossRefGoogle Scholar
  30. Ortiz-Molina, H. (2006). Top management incentives and the pricing of corporate public debt. Journal of Financial and Quantitative Analysis, 41(2), 317–340.CrossRefGoogle Scholar
  31. Smith, C. W., & Warner, J. B. (1979). On financial contracting: An analysis of bond covenants. Journal of Financial Economics, 7, 117–161.CrossRefGoogle Scholar
  32. Sundaram, R. K., & Yermack, D. L. (2007). Pay me later: Inside debt and its role in managerial compensation. The Journal of Finance, 62(4), 1551–1587.CrossRefGoogle Scholar
  33. Tung, F., & Wang, X. (2010). Bank CEOs, inside debt compensation and the financial crisis. Boston University and Emory University (unpublished manuscript).Google Scholar
  34. Wei, C., & Yermack, D. (2011). Investors’ reactions to CEOs’ inside debt incentives. Review of Financial Studies, 24, 3813–3840.CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2012

Authors and Affiliations

  1. 1.University of MinnesotaMinneapolisUSA

Personalised recommendations