SSRN-Pay Me Later: Inside Debt and its Role in Managerial Compensation by Rangarajan Sundaram, David Yermack:
"CEOs with high debt-based incentives manage their firms conservatively to reduce default risk; and that pension plan compensation strongly influences patterns of CEO turnover and CEO cash compensation."The authors make an inmportant contribution by pointing out the obvious: namely that CEOs get pain in ways other than cash and equity. This is a fact that has largely been overlooked by researchers (at least partially due to data availability). From the paper:
"a vast academic literature has emerged on executive compensation. A predominant focus of this literature has been equity-based compensation, paid in the form of restricted stock, stock options, and other instruments whose value is tied to future equity returns"
"Overlooked almost entirely is the widespread practice of paying top managers with debt."
CEO pay is rarely in the form of traditional market-based debt but several forms of pay (specifically pensions and long term deferred compensatation contracts) have the same characteristics as debt. In Jensen and Meckling terms this 'inside debt" is hypothesized to affect the incentives of the CEOs.
After a case study showing how deferred compenstaion and pension benefits were important in the Jack Welch/GE world, the authors show that this "inside debt" does make up a large portion of CEO pay and that this is more important as CEOs near retirement.
Using large firms (237 forms from teh Fortune 500 of 2002) the authors report the expected; debt does change behavior with managers becoming more risk averse.
(Rememeber if we assume managers are people and people respond to changes in incentives, then managers respond to incentives. So while important, the findings should not be seen as surprising.)
"As CEO pension values increase relative to their equity values, risk-taking as measured by distance-to default declines."Good (and important) stuff! I^3!!!
Sundaram, Rangarajan K. and Yermack, David, "Pay Me Later: Inside Debt and its Role in Managerial Compensation" (May 16, 2005). NYU, Law and Economics Research Paper No. 05-08; AFA 2006 Boston Meetings Paper. http://ssrn.com/abstract=717102