especially true for firms with 90 per cent or more of their debt structure based on a specific
class of debt. However, when the interaction between inside debt and firm size (a proxy for
information asymmetry) is considered, larger firms with larger amounts of CEO inside debt
diversify their debt holdings.
Second, we examine the relationships between inside debt and the various components of total
debt. Firms with high CEO inside debt are more likely to use commercial paper, senior bonds
and commercial loans; have a higher percentage of debt from drawn credit lines; and have a
lower percentage of term loans; however, larger firms with high CEO inside debt are less likely to
use commercial paper and senior bonds; have a lower percentage of debt from drawn credit
lines and commercial loans; and have a higher percentage of debt from term loans.
Finally, specific components of debt important to debt holders, namely, interest rates and
maturity, are considered. As higher inside debt compensation is associated with lower
levels of CEO risk-seeking behavior (Cassell et al., 2012), CEO’s with higher debt
compensation might be expected to make bonds less risky and thus warranting a lower
rate. However, after controlling for factors related to bankruptcy, such as profitability and
cash flow volatility, we find firms with higher inside debt tend to reward debt holders, on
average, with higher interest rates and longer issue maturities. Higher inside debt,
especially above the firm’s debt-to-equity ratio, incentivizes the CEO to cater more to the
needs and desires of debt holders through higher interest payments, just as shareholders
prefer higher dividends. In addition, longer maturities are preferred for investors concerned
about retirement. Similarly, Sundaram and Yermack (2007) find CEOs with higher inside
debt are also concerned with longer time horizons. However, the effect is the opposite for
larger firms with large CEO inside debt holdings. One explanation for this can be
asymmetry. In smaller firms, the issuance of long-term securities is more of a signal of
sustainability, and thissignal is more believable the more inside debt the CEO has, whereas
in larger firms, the long-term sustainability of the firm is less of a concern; thus, there is no
need to signal and thus the CEO makes conservativesafe decisions.
This paper contributes to the literature in several ways. First, we provide another variable to
consider with supply-side effect analysis of debt specialization with insid e debt. Second, we
provide a benchmark for future analysis of specific debt instruments left unexplored, incl uding
total trust-preferred stock, a component of “other” debt. Third, we demonstrate structures of
inside debt and firm debt are interrelated. Finally, the evidence here provides regulatory
authorities with further evidence on how CEO inside debt affects financial deci sion-making.
The remainder of the paper is organized as follows. Section 2 describes the characteristics
of debt, both for the firm and CEO, in the context of the USA. Section 3 provides a
theoretical framework, leading to an empirical literature review and hypotheses
development in Section 4. Section 5 describes the research design implemented to provide
findings, which are discussedin detailin Section 6. Section 7 summarizes and concludes.
2. CEO inside debt, firm debt and executive compensation
Firm capital structure and Chief Executive Officer (CEO) compensation structure have been
of interest to academicians and regulators for years. Until recently, capital structure has
been analyzed in the context of total debt and total equity. However, the Capital IQ
database, starting in 2001, provides details of debt capital structure, such as types and
term structures of debt instruments. New studies by Rauh (2006) and Colla et al. (2013)
introduce the use of the new and comprehensive Capital IQ database to break down the
components of total debt, into commercial paper, drawn credit lines, senior and
subordinated bonds and notes, term loans and capital leases. Firms who debt specialize
have higher bankruptcy costs, are less transparent and lack access to debt markets.
However, their work did not include consideration of CEO compensation incentives, which
could influence decision-makingon financial policies.
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