Executive bonus compensation and financial leverage: do growth and executive ownership matter?

• DOI: https://doi.org/10.1108/IJAIM-09-2020-0141
• Published date: 19 May 2021
• Date: 19 May 2021
• Pages: 392-409
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Emmanuel Adu-Ameyaw,Albert Danso,Samuel Acheampong,Cynthia Akwei

Executive bonus compensation

and financial leverage: do growth

and executive ownership matter?

Emmanuel Adu-Ameyaw

Bristol Business School, University of the West of England, Bristol, UK

Albert Danso

Leicester Castle Business School, De Montfort University, Leicester, UK

Samuel Acheampong

Departmentof Economics, University of Kentucky, Lexington, Kentucky, USA,and

Cynthia Akwei

Liverpool Business School, Liverpool John Moores University, Liverpool, UK

Abstract

Purpose –This study aims to examine the impact of executive bonus compensationon a firm’sfinancial

leverage policyand the extent to which this compensation–leverage relation is moderatedby firm growth and

executiveownership.

Design/methodology/approach –Using data from 213 non-financial and non-utility UK FTSE 350

firms for the period 2007–2015,generating a total of 1,784 firm-year observations,panel econometric methods

are used to test the model.

Findings –Drawing insights from agency theoreticview, this paper uncovers that managerial cash bonus

compensation is negatively and significantly related to financial leverage. However, stock bonus

compensationhas a positive and significant impact on leverage. This study also observes that compensation–

leverage is moderatedby both firm growth and executive ownership. The results remain robust to alternative

econometricmodels.

Originality/value –While this paper builds on the risk-motivated argument of executive bonus

compensation literature, it is the first –to the best of the knowledge –to explore the bonus compensation-

corporate financial leverage and, particularly, examine the extent to which firm growth and corporate

executiveownership matter in this relationship.

Keywords UK, Leverage, Executive bonus compensation

Paper type Research paper

1. Introduction

Executive compensation has garnered a great deal of attention from both academics and

non-academics. This narrative stems in part from flaws in various corporate

compensation practices which were revealed following the 2007–2008 global financial

crisis. It is, therefore, not surprising that shareholder votes on executive compensation

have been introduced in several countries within Europe (Ferri and Maber, 2013).

Broadly, prior scholarly work suggests that executive bonus compensation can be used

as a tool in aligning the interests of corporate managers with those of shareholders

JEL classification –G30, G32, G34

IJAIM

29,3

392

Received7 September 2020

Revised1 January 2021

Accepted4 February 2021

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 3, 2021

pp. 392-409

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-09-2020-0141

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

(Balafas and Florackis, 2014;Kaplan and Rauh, 2010;Ortiz-Molina, 2007). Indeed,

effective bonus compensation policies such as incentive-based pay could persuade firm

executives to use costly effort to enhance the future growth opportunities of their firms,

thereby eliminating the agency conflicts between managers and shareholders and this

eventually creates shareholder value. Accordingly, the agency problem between

corporate managers and shareholders is minimised through optimal compensation

incentives (Balafas and Florackis, 2014;Grout and Zalewska, 2010;Ortiz-Molina, 2007;

Jensen and Meckling, 1976). Notwithstanding the growing theoretical and empirical

interest in executive bonus compensation, our understanding of the strategic implication

of executive bonus compensation is far from complete. Results from prior scholarly

advances have been mixed and unclear. Thus, in this study, we examine the influence of

both cash bonus compensation and stock bonus compensation on a firm’sfinancial

leverage policy by using panel data of 213 non-financial and non-utility UK FTSE 350

firms for the period 2007–2015. Examining these executive bonus compensations on firm

capital structure decision is important because it provides important insight into how top

management incentives affect firms’key strategic decision –capital structure decision.

Further, we seek to understand the extent to which the executive bonus compensation–

leverage relation is conditional on firm growth and executive ownership. In the UK, a

series of corporate governance reforms have been initiated to curb lavish executive bonus

compensations (Cho et al., 2019;Conyon et al., 2001). In spite of these reforms, the

excessive executive bonus is regarded as one of the main factors that led to the collapse of

many UK institutions during the 2007–2008 financial crisis (von Ehrlich and Radulescu,

2017). Thus, the UK presents a unique context for testing how executive bonus

compensation drives a firm’sfinancial leverage policy

By way of preview, the evidence obtainedin this study shows that executive cash bonus

compensation negativelyimpacts firm leverage. This suggests that incentives for executives

to adopt excessive financial leverage are lessened through the adoption of a cash bonus. In

effect, executives with cash bonus incentives are motivated to generate enough cash flow

which enables the firm to sponsor corporate activities with internally generated funds.

Thus, this reduces the likelihood of bankruptcy conflict as a result of less usage of debt

within the capital structure of the firm. However, our analysis reveals that executives’stock

bonus compensation has a positive and significant influence on a firm’sfinancial leverage.

This suggests that stock–based bonusinduces executives to allow greater debt levels in the

capital structure of their firms. Also, we find that growth opportunitynegatively moderates

both cash bonus compensation–leverage and stock bonus compensation–leverage

relationships. Further,we observe that executive ownership negatively moderates the stock-

based bonus–leverage relationship. This suggests that stock-motivated executives with

large ownership stakes preferto keep a lower leverage ratio in the firm’s capital structure to

minimise their personal and economic risks resulting from the firm’s possible bankruptcy

risk (Grossman and Hart, 1982). Additionally, because debtholders and other lenders are

likely to monitor and restrainmanagerial activities, stock-incentivised executiveswith more

ownership stakes may have an opportune incentive to lower debt levels to prevent external

control (Brailsford and Pua, 2002). Indeed, we conduct several tests to ascertain the

robustness of our results. Firstly, we measure both executive cash and stock bonus

compensations by using alternativeproxies. Secondly, in addition to OLS estimation, we use

the fixed effects model to deal with time-invariant covariates. Finally, we address the issue

of endogeneity and reverse causalityby using both the predicted model approach and three-

stage least squares (3SLS) estimations. Our results remain robust to all these tests and

alternative estimationsused to analyse the data.

Bonus

compensation

and financial

leverage

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