Executive Equity Risk-Taking Incentives and Firm's Choice of Debt Structure

54 Pages Posted: 19 Oct 2017 Last revised: 22 Apr 2020

See all articles by Yangyang Chen

Yangyang Chen

City University of Hong Kong (CityUHK) - Department of Accountancy

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Walid Saffar

Hong Kong Polytechnic University - School of Accounting and Finance

Leon Zolotoy

University of Melbourne - Melbourne Business School

Date Written: April 22, 2020

Abstract

We examine how executive equity risk-taking incentives affect firms’ choice of debt structure. Using a longitudinal sample of U.S. firms, we document that when executive compensation is more sensitive to stock volatility (i.e., has higher vega), firms reduce their reliance on bank debt financing. We utilize the passage of the Financial Accounting Standard (FAS) 123R option-expensing regulation as an exogenous shock to management option compensation to account for potential endogeneity. In cross-sectional analyses, we find that the documented effect of vega is amplified among firms with higher growth opportunities and more opaque financial information; we also find vega’s effect is mitigated in firms with limited abilities to tap into public debt market. Supplemental analyses suggest that firms with higher vega face more stringent bank loan covenants. We conclude that, by encouraging risk-taking, higher vega reduces firms’ reliance on bank debt financing in order to avoid more stringent bank monitoring.

Keywords: Executive equity incentives; Vega; Bank debt; Debt structure

JEL Classification: G21, G32, M41, M42

Suggested Citation

Chen, Yangyang and Hasan, Iftekhar and Saffar, Walid and Zolotoy, Leon, Executive Equity Risk-Taking Incentives and Firm's Choice of Debt Structure (April 22, 2020). Available at SSRN: https://ssrn.com/abstract=3055467 or http://dx.doi.org/10.2139/ssrn.3055467

Yangyang Chen

City University of Hong Kong (CityUHK) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China

Iftekhar Hasan

Fordham University ( email )

45 COLUMBUS AVENUE
GBA-5TH FLOOR
NEW YORK, NY 10023
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

Walid Saffar (Contact Author)

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Li Ka Shing Tower
Hong Hum
Kowloon
Hong Kong

Leon Zolotoy

University of Melbourne - Melbourne Business School ( email )

200 Leicester Street
Carlton, Victoria 3053 3186
Australia

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