Executive Compensation and Corporate Risk-Taking: Evidence from Private Loan Contracts

Abstract

We study how FAS 123R affects the cost of bank loans. Using a difference-in-differences approach, we find that spreads on loans to firms that did not expense options before FAS 123R (treated firms) decrease significantly after FAS 123R relative to firms that either did not issue stock options or voluntarily adopted fair value accounting for stock options before 123R (control firms). We also find that loans taken by the treated firms are less likely to contain collateral requirements and are less likely to have covenants restricting capital investment post-FAS 123R. Taken together, our results suggest FAS 123R reduces firms’ cost of debt due to reduced agency costs of debt over CEOs’ risk taking.