Inside Debt and Risk: Is There A Link?

Abstract

The disclosure of CEOs' pension benefits and deferred compensation in 2007 provided scholars with the opportunity to test agency theory predictions on these long-term compensations, also known as inside debt. While the studies showed this form of payment as an effective tool in controlling excessive risk, they all overlapped with the financial crisis of 2007 and its aftershocks. Drawing on behavioral agency model and focusing on corporate mergers and acquisitions as a high-risk investment strategy, we demonstrate that neither CEOs nor shareholders remain sensitive to inside debt after the economy recovers. Our analysis of nearly 4000 observations in a post-crisis period (2011-2017) reveals that the previous findings are heavily influenced by the collapse of financial markets. Disproving agency theory arguments on debt-like compensation, our results point to the more realistic assumptions of behavioral decision models and call for more contingency approaches to theoretical inference. Practical implications are also discussed for designing executives’ compensation packages as a means of mitigating the next potential crises.