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Capital structure, executive compensation, and investment efficiency

Assaf Eisdorfer, Carmelo Giaccotto and Reilly White

Journal of Banking & Finance, 2013, vol. 37, issue 2, 549-562

Abstract: This paper examines how the similarity between the executive compensation leverage ratio and the firm leverage ratio affects the quality of the firm’s investment decisions. A larger leverage gap (i.e., a bigger difference between these two ratios) leads to more investment distortions. Managers with more debt-like compensation components tend to under-invest, whereas managers with larger equity-based compensation engage more in over-investment. Furthermore, investment distortion is likely to increase the equity (debt) value when compensation leverage is lower (higher) than firm leverage. These findings suggest that managers can deviate from an optimal investment policy to increase the value of their portfolio, and that a lower leverage gap can reduce agency costs.

Keywords: Capital structure; Executive compensation; Agency costs; Investment (search for similar items in EconPapers)
JEL-codes: G31 G32 J33 (search for similar items in EconPapers)
Date: 2013
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Handle: RePEc:eee:jbfina:v:37:y:2013:i:2:p:549-562