CEO Bonus Pay and Firm Credit Risk

Abstract

This article examines the association between the bonus component of managerial compensation and the impacts on a firm's credit risk using data from the U.S. The empirical findings suggest that bonus compensation could potentially play a role in mitigating the agency costs of debt and restraining the CEO's risk-taking behavior, as bonus pay is significantly associated with lower credit risk in a broad sample across various industries. Cash compensation including salary and bonuses, however, have different impacts on credit risk. Bonus compensation does not add to credit risk as suggested in the financial press, but firms should differentiate impacts of bonus and salary pay on firm risk when designing executives' compensation package.