Executive pay disparity and cost of debt financing

Purpose - This paper aims to examine the relationship between executive pay disparity and the cost of debt. Design/methodology/approach - The authors use a sample of syndicated bank loans granted to United States (US) listed firms from 1992 to 2014 and adopt the loan yield spread (Chief Executive Officer (CEO) pay slice) as the main proxy for the cost of debt (executive pay disparity). The authors also use the Heckman two-stage model to address the sample selection bias and the two-stage least squares and propensity score matching methods to control the potential endogeneity issues. To test different views about executive pay disparity, the authors adopt the cash-to-stock ratio to proxy for managerial risk-shifting incentives. Findings - The authors find that the cost of debt is significantly higher for firms with larger executive pay disparity, which is robust to sample selection bias, endogeneity concerns, alternative measures and various controls. This positive relationship increases with the risk-shifting incentives of CEOs instead of other top executives, which supports the managerial power view, and is stronger for firms with higher levels of financial distress. The findings suggest that creditors view executive pay disparity are associated with higher credit risk and CEO entrenchment. Originality/value - This paper reveals one “dark” side of executive pay disparity: it increases the cost of debt and identifies a significant role played by CEOs' risk-shifting incentives. The authors provide direct evidence of the relevance of pay differential to corporate credit analysis.