Accounting-Based Compensation and Debt Contracts

Authors

Zhi Li, Chapman UniversityFollow
Lingling Wang, University of Connecticut
Karen Wruck, Ohio State University

Document Type

Article

Publication Date

10-22-2019

Abstract

We examine how accounting‐based compensation plans influence a firm's contracts with its creditors. After granting long‐term accounting‐based compensation plans (LTAPs) to CEOs, firms pay lower spreads and have fewer restrictive covenants in new bank loans. Mechanisms leading to lower borrowing cost include improvements in debt repayment ability, reduced shareholder‐debtholder conflicts, and reduced risk‐taking incentives. Creditors view LTAPs as a substitute for monitoring, adjust covenant design based on LTAP features, and value plans with concave performance‐payout functions and reasonable performance targets. A firm's credit rating improves and CDS spread declines after LTAP grants, suggesting that LTAPs help reduce firms' credit risk.

Comments

This article was originally published in Contemporary Accounting Research in 2020. https://doi.org/10.1111/1911-3846.12574

Recommended Citation

Li, Z., Wang, L. and Wruck, K. (2020), Accounting‐Based Compensation and Debt Contracts. Contemp Account Res. https://doi.org/10.1111/1911-3846.12574

Peer Reviewed

1

Copyright

Canadian Academic Accounting Association (CAAA)