An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Chan Du
Boston University

Abstract: Compensation studies suggest that equity-based compensation can align the interests of shareholders and managers in terms of managerial risk taking choices. This study extends the literature by examining whether equity-based compensation is used to incorporate the interests of bondholders with those of managers and shareholders in terms of managerial risk taking. In particular, it hypothesizes that equity-based compensation induced managerial risk taking are different for firms with and without asset substitution problems. Using a simultaneous equations model with CEO compensation from 1992 – 2004, the data shows that CEOs act differently for firms with different financial structure and different ex ante financial distress risk. The sensitivity of CEO wealth to stock returns volatility (PRS) has a lower impact on managerial risk taking for debt-financed firms relative to equity-financed firms, and a lower impact for high distress risk firms relative to low distress risk firms.

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