Optimal Composition of Private and Public Debt, and CEO Compensations Under Moral Hazard and Asymmetric Information

Abstract

This paper analyzes link between optimal CEO compensations and the optimal mix of private and public debt issued by a firm to resolve agency problems. We show that, absent adverse selection issues, optimal managerial compensation under moral hazard takes the form of a stock based compensation plan. The firm finances exclusively with bank loans and does not issue any public debt. However, with both types of agency problems, there is an optimal mix of private and public debt, and the optimal managerial compensation is shown to depend on growth opportunities, assets-in-place as well as the amount of public debt. Thus composition of debt is shown to influence CEO compensations under asymmetric information. While the mix of two types of debt enhances value of the firm ex-ante, ex-post it leads to inefficient restructuring.