CEO Inside Debt Compensation and Performance of the Real Sector Firms during Crisis

Abstract

This paper tests whether CEO inside debt incentive has any relation with the performance of the real sector firms during crisis. Agency theory predicts that a relatively high proportion of inside debt compensation aligns CEO interest with debt holders, who prefer less risky investment. Research on banking sector finds that this alignment of interest makes bank CEOs conservative decision makers and augments the firm performance during crisis. Motivated by these findings, we expect the CEOs of real sector with higher inside debt to be risk averse as well during crisis period and thus increase the performance of the firm. Using a sample from S&P 1500 firms of the U.S. over the period of 2006-2010, we find that, as predicted, CEO relative inside debt is positively associated with the accounting measure of performance as measured by return on assets (ROA). CEO inside debt is also positively associated with alternative measure of firm performance reflecting firm’s investment value as measured by the Tobin’s Q, although it loses significance to some extent. We address potential endogeneity between inside debt and firm performance using 3SLS regressions and find the same result as of Pooled OLS. Results are robust to the sample of core crisis period of 2008-09 and different measures and components of inside debt ratios. Therefore, CEO inside debt plays a significant role in maintaining better performance of the real sector firms during crisis period.