CEO incentives and the cost of debt

• Published in: Review of quantitative finance and accounting Vol. 38; no. 3; pp. 323 - 346
• Main Author: Shaw, Kenneth W.
• Format: Journal Article
• Language: English
• Published: Boston Springer US 01.04.2012; Springer Nature B.V
• Subjects: Accounting procedures; Accounting/Auditing; Chief executive officers; Compensation plans; Corporate debt; Corporate Finance; Costs; Debt; Econometrics; Economics and Finance; Executive compensation; Finance; Financial incentives; Incentives; Operations Research/Decision Theory; Options on stocks; Original Research; Proxy statements; Stock options; Stock prices; Stock returns; Stockholders; Studies; Volatility; Cost of debt; M41; M52; Stock options; CEO compensation
• ISSN: 0924-865X; 1573-7179
• DOI: 10.1007/s11156-011-0230-7

Motivated by concerns that stock-based compensation might lead to excessive risk-taking, this paper’s main purpose is to examine the relations between CEO incentives and the cost of debt. Unlike prior research, this paper uses the sensitivities of CEO stock and option portfolios to stock price (delta) and stock return volatility (vega) to measure CEO incentives to invest in risky projects. Higher delta (vega) is predicted to be related to lower (higher) cost of debt. The results show that yield spreads on new debt issues are lower for firms with higher CEO delta and are unrelated to CEO vega. The results also show that yield spreads are higher for firms whose CEOs hold more shares and stock options. In sum, the results suggest that both percentage-ownership and option sensitivity variables are important in understanding relations between CEO incentives and the cost of debt.