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CEO inside debt holdings and risk-shifting: Evidence from bank payout policies

Abhishek Srivastav, Seth Armitage and Jens Hagendorff

Journal of Banking & Finance, 2014, vol. 47, issue C, 41-53

Abstract: Bank payouts divert cash to shareholders, while leaving behind riskier and less liquid assets to repay debt holders in the future. Bank payouts, therefore, constitute a type of risk-shifting that benefits equity holders at the expense of debt holders. In this paper, we provide insights on how CEO incentives stemming from inside debt (primarily defined benefit pensions and deferred compensation) impact bank payout policy in a manner that protects debt holder interests. We show that CEOs with higher inside debt relative to inside equity are associated with more conservative bank payout policies. Specifically, CEOs paid with more inside debt are more likely to cut payouts and to cut payouts by a larger amount. Reductions in payouts occur through a decrease in both dividends and repurchases. Our results also hold over a subsample of TARP banks where we expect the link between risk-shifting and payouts to be of particular relevance because it involves wealth transfers from the taxpayer to equity holders. We conclude that inside debt can help in addressing risk-shifting concerns by aligning the interests of CEOs with those of creditors, regulators, and in the case of TARP banks, the taxpayer.

Keywords: Banks; Inside debt; CEO incentives; Payout; Dividends (search for similar items in EconPapers)
JEL-codes: G21 G28 G34 J33 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1016/j.jbankfin.2014.06.016

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Handle: RePEc:eee:jbfina:v:47:y:2014:i:c:p:41-53