Working Paper: NBER ID: w24064
Authors: Jongsub Lee; Junho Oh; David Yermack
Abstract: We show in a theoretical model that credit default swaps induce managerial agency problems through two channels: reducing the opportunity for managers to transfer value to equityholders from creditors via strategic default, and reducing the intensity of monitoring by creditors, which leads to greater CEO diversion of assets as perquisites. We further show that boards can use compensation awards that increase managerial performance incentives (delta) and risk-taking incentives (vega) in order to mitigate these two agency problems, with increases in managerial vega being particularly useful to alleviate the strategic default-related agency problem. We study equity compensation awards to CEOs of S&P 1500 companies during 2001–2015 and find that they occur in patterns consistent with these predictions.
Keywords: credit default swaps; agency problems; management incentives
JEL Codes: G30; G33; G34; J33; M52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CDS introduction (Y20) | decrease in likelihood of strategic default by managers (G32) |
| decrease in likelihood of strategic default by managers (G32) | reduced opportunity for managers to transfer value from creditors to equityholders (G32) |
| CDS presence (C10) | changes in managerial behavior and decision-making (D91) |
| reduced monitoring intensity by creditors (G32) | diminished oversight of managerial actions (G34) |
| boards of directors adjusting managerial compensation packages (M12) | mitigation of agency problems (G34) |
| increase in delta and vega of equity compensation awards (M52) | increase in managerial vega (M12) |
| increase in delta of managerial compensation (M12) | increase in CEO wealth (M12) |
| increasing vega (C69) | alleviating strategic default-related agency problem (G33) |
| delta adjustments (C69) | not addressing strategic default-related agency problems effectively (G33) |