Aligning interests : the impact of CEO compensation schemes on corporate executive behaviour and the cost of debt : a thesis presented in fulfilment of the requirements for the degree of Doctor of Philosophy in Finance, Massey University, Palmerston North, New Zealand

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Massey University
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A key element of corporate governance is executive compensation. This study examines the effectiveness of two compensation methods for chief executives: inside debt and vesting equity. In essay one, inside debt aligns management incentives with inside bondholder incentives (since they both hold debt), resulting in less risky corporate policies and reducing corporate risk-taking. This study shows empirically that inside debt is associated with less problematic situations (i.e., small earnings declines), less real activity spending cuts (such as marketing and R&D research), and lower yield spreads on corporate bonds. In essay two, company executives and bond investors are concerned about short-term prices. When executives’ compensation includes vesting equity, their interests are aligned. In this study, vesting equity reduces the cost of debt. Among the two components of vesting equity, the option lowers costs of debt, while stock keep costs high. The results suggest investors view vesting options as the best way to align executives’ and bondholders’ interests. Vesting equity may also reduce risk-taking activities, affecting bond prices. In summary, the results show that bondholders are aware of the risk-taking and risk-avoidance incentives created by executive compensation schemes. Inside debt and vesting equity strengthen and align executive interests with those of inside and external bondholders.
Executives, Salaries, etc, Risk management, Corporate debt