Differential risk effect of inside debt, CEO compensation diversification, and firm investment

Cheng Few Lee, Chengru Hu () and Maggie Foley
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Chengru Hu: SUNY at Canton
Maggie Foley: Jacksonville University

Review of Quantitative Finance and Accounting, 2021, vol. 56, issue 2, No 5, 505-543

Abstract: Abstract The main purposes of this paper are to study (1) a differential effect of inside debts on components of the firm risk, and (2) how it relates to the diversification of CEOs’ portfolios to reduce exposures to the firm risk. We find that compensating CEOs with inside debts (e.g., pensions and other deferred compensation plans) leads to reductions in firms’ systematic risk and idiosyncratic risk, but to disproportionate degrees. CEOs with larger inside debts draft and implement policies, which lead to a significantly larger reduction in the idiosyncratic firm risk and investment. We then show that the differential effect is the result of an asymmetry in CEOs’ perceived benefits of diversifying exposures to individual firm risk components. We further show that granting excessive debt-based pay may divert executives from firm specific but productive activities (e.g., R&D investments), therefore may compromise the long-run corporate success.

Keywords: Executive compensation; Inside debt; Risk-taking incentive; Systematic and idiosyncratic risk; R&D investment; Diversification (search for similar items in EconPapers)
JEL-codes: G32 J33 L25 M12 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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DOI: 10.1007/s11156-020-00901-0

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