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Negative Hedging: Performance Sensitive Debt and CEOs’ Equity Incentives

Authors: Tchistyi, Alexei
Yermack, David
Yun, Hayong
Keywords: Performance sensitive debt;equity compensation
Issue Date: 8-Dec-2007
Series/Report no.: FIN-07-043
Abstract: We examine the relation between CEOs’ equity incentives and their use of performance-sensitive debt contracts. These contracts require higher or lower interest payments when the borrower's performance deteriorates or improves, thereby increasing expected costs of financial distress while also making a firm riskier to the benefit of option holders. We find that managers whose compensation is more sensitive to stock price volatility choose steeper and more convex performance pricing schedules, while those with high delta incentives choose flatter, less convex pricing schedules. Performance pricing contracts therefore seem to provide a channel for managers to increase firms’ financial risk to gain private benefits.
Appears in Collections:Finance Working Papers

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