Executive pensions, compensation leverage, and firm risk

Abstract

Purpose

The purpose of this paper is to investigate how the structure of both CEO and non-CEO executive compensation affects the overall risk of a firm. The author focuses on the interplay between CEO and non-CEO executive compensation structure.

Design/methodology/approach

The author uses a hand-collected pension-database that employs both OLS and two-stage least squares regressions to determine the effects of inside debt on default risk using the distance-to-default framework. The database consists of 8,965 executive-year data points from 272 firms.

Findings

This paper accomplishes three major objectives: first, the author presents a significant extension of Sundaram and Yermack (2007) by including non-CEO executives; the author demonstrates how the differences in inside debt between CEO and non-CEO executives are directly related to firm risk; and that funding these pensions via a Rabbi Trust eliminates most of the risk-shifting effects. Firms with the lowest compensation leverage gap between CEO and non-CEO executives were most likely to observe the agency costs associated with high executive leverage. When compensation leverage structures were substantially different, or the pension was pre-funded, these effects are neutralized.

Originality/value

To the best of the author’s knowledge, the first paper addresses the effects of Rabbi Trusts on risk-shifting behavior between both CEOs and non-CEO executives. Further, the author extends Sundaram and Yermack (2007) using a hand-collected database six times larger than the original paper. By focusing on the “leverage gap” between CEOs and non-CEO executives, the author presents unique evidence that underlines the risk dynamics between CEOs and their boards.

Citation

White, R. (2018), "Executive pensions, compensation leverage, and firm risk", International Journal of Managerial Finance, Vol. 14 No. 3, pp. 342-361. https://doi.org/10.1108/IJMF-08-2017-0172