Inside Debt: Bondholder and Shareholder Perspectives: Response to Recent Literature

Abstract

While much of the prevailing academic corporate finance theory has focused on executive compensation composed of equity instruments, recent literature has advocated for the inclusion of “inside debt”, a concept penned by Jensen and Meckling (1976), in executive compensation structures as a means to effectively align executives with their respective bondholders. This in turn is believed to mitigate the firms’ agency costs of debt, subsequently benefitting all company claimants. Sundaram and Yermack (2007) provide evidence of significant prevalence of inside debt among large U.S. firms. This paper explores the implications of debt compensation and finds a significant negative correlation between chief executive inside debt holdings and the respective firm’s actual cost of long term debt. The model and results promoted in this paper can most definitely function as a necessary stepping stone for further research on the topic.