Bank Monitoring and CEO Compensation

Abstract

This paper investigates whether monitoring by banks and other types of lenders of private corporate loans has impact on equity incentives for CEOs (mainly options and restricted stocks). The results of this paper show that CEOs of companies with private corporate loans tend to have lower proportion of options and equity-based compensation and lower level of total compensation. Such effect is more profound when the borrowing company’s credit quality is lower. These results are consistent with the conjectures that corporate loan creditors such as banks play an important role in monitoring their borrower, that bank monitoring could be a substitute for performance-sensitive pay of CEOs, and/or that private creditors prefer a CEO compensation structure that is aligned less with the shareholder interests to deter risk-shifting behavior of managers. This paper further shows that monitoring by banks reduce the degree of sensitivity of CEOs’ pay for “luck”, which is defined as the exogenous component of firm performance out of CEOs’ control.