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Negative Hedging: Performance-Sensitive Debt and CEOs’ Equity Incentives

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  • Tchistyi, Alexei
  • Yermack, David
  • Yun, Hayong

Abstract

We examine the relation between chief executive officers’ equity incentives and their use of performance-sensitive debt contracts. These contracts require higher or lower interest payments when the borrower’s performance deteriorates or improves, thereby increasing expected costs of financial distress while making a firm riskier to the benefit of option holders. We find that managers whose compensation is more sensitive to stock volatility choose steeper and more convex performance pricing schedules, while those with high delta incentives choose flatter, less convex pricing schedules. Performance pricing contracts therefore seem to provide a channel for managers to increase firms’ financial risk to gain private benefits.

Suggested Citation

  • Tchistyi, Alexei & Yermack, David & Yun, Hayong, 2011. "Negative Hedging: Performance-Sensitive Debt and CEOs’ Equity Incentives," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(3), pages 657-686, June.
    • Handle: RePEc:cup:jfinqa:v:46:y:2011:i:03:p:657-686_00
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    1. repec:hum:wpaper:sfb649dp2013-027 is not listed on IDEAS
    2. Timothy King & Jonathan Williams, 2013. "Bank Efficiency and Executive Compensation," Working Papers 13009, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    3. Yan Hu & Connie Mao, 2017. "Accounting quality, bank monitoring, and performance pricing loans," Review of Quantitative Finance and Accounting, Springer, vol. 49(3), pages 569-597, October.
    4. Adam, Tim R. & Streitz, Daniel, 2013. "Bank lending relationships and the use of performance-sensitive debt," SFB 649 Discussion Papers 2013-027, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    5. Adam, Tim R. & Burg, Valentin & Scheinert, Tobias & Streitz, Daniel, 2014. "Managerial Optimism and Debt Contract Design: The Case of Syndicated Loans," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 475, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    6. Mazur, Mieszko & Salganik-Shoshan, Galla, 2017. "Teaming up and quiet intervention: The impact of institutional investors on executive compensation policies," Journal of Financial Markets, Elsevier, vol. 35(C), pages 65-83.
    7. Gormley, Todd A. & Matsa, David A. & Milbourn, Todd, 2013. "CEO compensation and corporate risk: Evidence from a natural experiment," Journal of Accounting and Economics, Elsevier, vol. 56(2), pages 79-101.
    8. Zhi Li & Lingling Wang & Karen Wruck, 2020. "Accounting‐Based Compensation and Debt Contracts," Contemporary Accounting Research, John Wiley & Sons, vol. 37(3), pages 1475-1511, September.
    9. Mazur, Mieszko & Salganik-Shoshan, Galla, 2019. "The effect of executive stock option delta and vega on the spin-off decision," The Quarterly Review of Economics and Finance, Elsevier, vol. 72(C), pages 132-144.
    10. Adam, Tim R. & Streitz, Daniel, 2016. "Hold-up and the use of performance-sensitive debt," Journal of Financial Intermediation, Elsevier, vol. 26(C), pages 47-67.
    11. Bensoussan, Alain & Chevalier-Roignant, Benoît & Rivera, Alejandro, 2021. "Does performance-sensitive debt mitigate debt overhang?," Journal of Economic Dynamics and Control, Elsevier, vol. 131(C).
    12. Luxing Liu & Keyu Lei & Hong Jin & Yin-Pei Teng, 2023. "R&D Investment, Executive Incentive, and Financial Performance in GEM: Based on Three-Stage Least Squares Method," SAGE Open, , vol. 13(4), pages 21582440231, November.
    13. Alain Bensoussan & Benoit Chevalier-Roignant & Alejandro Rivera, 2021. "Does Performance-Sensitive Debt mitigate Debt Overhang?," Post-Print hal-03364891, HAL.
    14. Tim R. Adam & Valentin Burg & Tobias Scheinert & Daniel Streitz, 2020. "Managerial Biases and Debt Contract Design: The Case of Syndicated Loans," Management Science, INFORMS, vol. 66(1), pages 352-375, January.
    15. Sami Bacha, 2014. "Does Hedging Financing Ensure Shareholder Value: The Case of Investment Decision," International Journal of Empirical Finance, Research Academy of Social Sciences, vol. 3(5), pages 225-233.
    16. Thorburn, Karin S & Bienz, Carsten & Walz, Uwe, 2019. "Ownership, wealth, and risk taking: Evidence on private equity fund managers," CEPR Discussion Papers 13944, C.E.P.R. Discussion Papers.
    17. Shen, Carl Hsin-han & Zhang, Hao, 2013. "CEO risk incentives and firm performance following R&D increases," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1176-1194.

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