Abstract
I examine how CEO compensation packages and pay-performance sensitivities are related to firms' capital structures. The results are fully consistent with shareholders designing compensation contracts not only to align incentives with managers, but also to mitigate stockholder-bondholder conflicts regarding risk-taking. The evidence is also weakly consistent with higher debt reducing manager-shareholder conflicts. Specifically, I find that CEOs in more levered firms have lower pay-performance sensitivities estimated by the empirical relation between changes in a CEO's firm-related wealth and changes in shareholder wealth. Closer examination reveals that pay-performance sensitivity decreases in straight-debt leverage, but is higher in firms with convertible debt. In addition, stock option policy is the component of CEO pay that is most sensitive to cross-sectional differences in capital structure.
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