Working Paper: 2017-12-22
This paper shows that CEO compensation policies become more creditor-friendly when creditors' bargaining power increases, revealing a channel through which creditors indirectly influence corporate governance. Using a regression discontinuity design, we find that following loan covenant violations, firms provide fewer stock-options, reduce pay duration—especially when loan maturity is low, and contract on accounting-based goals when creditors do as well. By reducing risk-taking incentives and aligning pay duration and the choice of performance metrics with creditors' interests, CEO compensation policies appear to serve as commitment devices to decrease the agency cost of debt.
Working Paper: 2017-06-23
Contract theory has stressed the importance of human capital risk associated with management in debt contract design. Using a unique database of private loan contract terms, we find that when this risk is large, lenders include change of management restrictions (CMRs) in loan contracts. These restrictions give lenders explicit control over managerial retention and/or selection decisions. Our analysis also shows that lenders’ interplay with equity holders and the way equity holders (can) contract with management affects lenders’ decision to include a CMR. These results provide two implications that inform the theory: (i) human capital risk associated with management affects debt contracting, but the contracting space is broader than anticipated in existing models, and (ii) shareholders’ role in mitigating or exacerbating human capital risk faced by lenders is important in debt contract design. Finally, we find that the likelihood of CEO turnover more than halved during CMR terms suggesting that these clauses are respected by borrowers and that lenders can influence managerial turnover, even outside of default states.
Using risk factors as the unit of disclosure, I show that the managerial decision to add new, retain existing, and remove obsolete risk factors predicts future adverse reporting and real outcomes, providing novel evidence that managers are removing stale disclosures on a timely basis. After controlling for firm-specific heterogeneity, I find that the count of individual risk factors disclosed, rather than an aggregate word count, explains time-series variation in managerial disclosure decisions, consistent with the regulatory intent. I also examine the effect on the disclosure equilibrium by studying managerial response to demand shocks from public and private enforcement actions. The results show that firms respond to investor demand in a manner consistent with the litigation shield hypothesis, and that this effect persists for multiple years. Consistent with the regulatory cost-benefit function, public enforcement does not result in a net increase in disclosed risk factors, but does evoke more definitive disclosures with language that is more specific and an increased use of numbers. Finally, I find that managers provide additional risk factors prior to securities litigation, especially when they are subsequently settled, consistent with supply-side litigation shield effects.