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Differential Effect of Inside Debt, CEO Compensation Diversification, and Firm Investment

In: Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives In 4 Volumes

Author

Listed:
  • Cheng Few Lee
  • Chengru Hu
  • Maggie Foley

Abstract

The main purposes of this paper are to study (1) a differential effect of inside debt on components of firm risk, and (2) how it relates to CEO portfolio diversification to reduce firm risk exposure. We find that compensating CEOs with inside debt (e.g., pensions and other deferred compensation plans) leads to reductions in firms’ systematic risk and idiosyncratic risk, but to disproportionate degrees. CEOs with larger inside debt draft and implement policies, which lead to a significantly larger reduction in the idiosyncratic firm risk and investment. We then show that the differential effect is the result of an asymmetry in CEOs’ perceived benefits of diversifying exposures to individual firm risk components. We further show that granting excessive debt-based pay may divert executives from firm specific but productive activities (e.g., R&D investments), therefore may compromise longrun corporate success.

Suggested Citation

  • Cheng Few Lee & Chengru Hu & Maggie Foley, 2024. "Differential Effect of Inside Debt, CEO Compensation Diversification, and Firm Investment," World Scientific Book Chapters, in: Cheng Few Lee & Alice C Lee & John C Lee (ed.), Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives In 4 Volumes, chapter 110, pages 3627-3680, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811269943_0110
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    Keywords

    Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G1 - Financial Economics - - General Financial Markets
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing
    • G3 - Financial Economics - - Corporate Finance and Governance

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