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Dealing with Overleverage: Restricting Leverage vs. Restricting Variable Compensation

Pedro Gete and Juan Pedro Gomez

MPRA Paper from University Library of Munich, Germany

Abstract: We study policies that regulate executive compensation in a model that jointly determines executives effort, compensation and firm leverage. The market failure that justifies regulation is that executives are optimistic about asset prices in states of distress. We show that shareholders propose compensation packages that lead to socially excessive leverage. Say-on-pay regulation does not reduce the incentives for leverage. Regulating the structure of compensation (but not its level) with a cap on the ratio of variable-to-fixed pay delivers the right leverage. However, it is more efficient to directly regulate leverage because restricting the variable compensation impacts managerial effort more than if shareholders are free to design compensation subject to a leverage constraint.

Keywords: Executive Compensation; Leverage; Moral Hazard; Overborrowing; Optimism. (search for similar items in EconPapers)
JEL-codes: D86 G20 G28 (search for similar items in EconPapers)
Date: 2017-06
New Economics Papers: this item is included in nep-hrm
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Journal Article: Dealing with Overleverage: Restricting Leverage vs. Restricting Variable Compensation (2018) Downloads
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