Abstract
CEO option compensation and the capital structure decision are simultaneously made choices. Using the Internal Revenue Code 162(m) tax law as an exogenous shock to compensation structure in a natural experiment setting, I can identify firm leverage changes as a result of CEO option compensation changes. The evidence provides strong support for debt agency theory. The results indicate firms decrease leverage when CEOs are paid with more options, and when CEO options become a higher percentage of future cash flows. The findings remain robust after controlling for corporate governance and convertible debt.
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