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What's good for you is good for me: The effect of CEO inside debt on the cost of equity

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  • Shen, Carl Hsin-han
  • Zhang, Hao

Abstract

We find an overall negative relation between CEO inside debt holdings and the cost of equity capital. Such a negative relation holds in an instrumental-variable analysis, a test using changes in variables due to CEO turnover events, a test using seasoned equity offering (SEO) underpricing as an alternate cost of equity measure, and a difference-in-differences test based on the implementation of Internal Revenue Code Section 409A Final Regulations. Additionally, the negative relation between inside debt and the cost of equity capital is nonlinear, suggesting the existence of optimal inside debt compensation that can minimize cost of capital. The negative relation is less pronounced in firms with pre-funded executive pension plans and in firms that provide executives with the pension lump-sum option. We also provide evidence that inside debt lowers the cost of equity more for excessively levered firms. Collectively, these findings suggest that shareholders value the beneficial role of CEO debt-like compensation in constraining excessive managerial risk taking.

Suggested Citation

  • Shen, Carl Hsin-han & Zhang, Hao, 2020. "What's good for you is good for me: The effect of CEO inside debt on the cost of equity," Journal of Corporate Finance, Elsevier, vol. 64(C).
    • Handle: RePEc:eee:corfin:v:64:y:2020:i:c:s0929119920301437
    DOI: 10.1016/j.jcorpfin.2020.101699
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