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CEO Incentives and the Cost of Debt
Ken Shaw,
University of Missouri
ABSTRACT. Motivated by concerns that stock-based compensation might lead to excessive risk-taking, this paper examines the relations between CEO incentives and the cost of debt. Unlike prior research, this paper uses the sensitivities of CEO stock and option portfolios to stock price (delta) and stock return volatility (vega) to measure CEO incentives. Higher delta (vega) is predicted to be related to less (greater) risk-seeking, and thus lower (higher) cost of debt. The results show that yield spreads on new debt issues are lower for firms with higher CEO delta, and are unrelated to CEO vega. While yield spreads are higher for firms whose CEOs hold more shares and options, a sample firm at the 3rd quartile level of each of this study’s CEO incentive variables would expect an estimated 26 basis point reduction in yield spread on a new debt issue, relative to a sample firm at the median level of the CEO variables. In sum, CEO incentives are related to a lower cost of debt.
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