Abstract
This paper investigates whether the current level of tournament incentives for top executives is related to the firm’s future credit rating. Greater pay dispersion (our proxy for tournament incentives) has been found to be associated with both greater firm performance and greater firm riskiness. Taking the bondholders’ perspective, credit rating agencies would view increases in performance favorably and increases in riskiness unfavorably, leading to the empirical question of how pay dispersion affects a firm’s credit rating, if at all. We find strong evidence that pay dispersion is negatively associated with credit ratings. We also find that the negative impact of pay dispersion on credit ratings is stronger when firms have greater default risk. Finally, we find weak evidence that strong shareholder rights accentuate the negative relation between pay dispersion and credit ratings.
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