Capital Structure And Executive Compensation

Abstract

The finance literature is not unanimous regarding the relationship between capital structure and executive compensation. As a firm increases its debt ratio (i.e., ratio of total debt to total assets), its risk of potential bankruptcy also increases. Because of that fact, stock price of the firm generally decreases after the announcement of its bond offering in the market place, thereby decreasing the shareholders' return and the value of the firm. As a result, we would expect less executive compensation (either salary bonuses, or total compensations which include stock option) when a firm issues a substantial bond offering and the price of its stock declines. We have found that there was a positive and statistically significant association between the salary and bonus of the CEOs of the 336 largest U.S. corporations, and the debts these firms incurred during the 1989-1999 time period. This was also true when total compensation (which included realized stock options) of the CEOs was taken as the dependent variable, although the latter was less effective than the former one.